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The Saga of the Self-Employed Borrower

How owning your own business impacts your ability to secure a home loan.

Written by Adam Headley
How to Get a Mortgage as a Self-Employed Borrower
Photo: Green Chameleon / Unsplash

The old adage, “Trust…but verify,” might well be applied to the self-employed mortgage borrower. Whether seeking a loan for a conventional house, a condominium, a log or timber home or any other residential property, a self-employed individual is subject to the same qualifying process as anyone else, but he or she may find they have to jump through a few extra hoops to prove their income.
While all mortgage lenders will evaluate a person’s credit history, scheduled debt payments, available cash for a down payment and closing costs, if a purchase is involved, the typical requirement of ongoing, steady and verifiable income is the most challenging for those who are self-employed. Mortgage applicants who receive their income from an employer that provides an annual W-2 statement generally experience little difficulty in proving their historical income. The W-2 information flows to the personal income tax return, and two years of returns typically are sufficient to verify income.
However, self-employed borrowers sometimes experience fluctuations in personal income, and these fluctuations may pose a challenge in the qualification process. Lenders regularly define self-employed borrowers as those who receive the majority of their revenue verification via Form 1099 or those who own their own business, filing Schedule C with their personal income tax return. Such borrowers usually earn a living as freelance workers, contractors, seasonal employees or gig workers. 
Some self-employed borrowers report income from businesses they own on other types of supporting schedules as components of their personal income tax returns. Further, self-employed borrowers who receive income from clients in foreign countries do not even receive the 1099. However, this still constitutes taxable income, and the individual is required to track and report it to the IRS.
So, when mortgage lenders require two years of steady, verifiable income, how does a self-employed borrower answer the call?
Documenting cash flow is critical to success. Demonstrating stability is the key, and underwriters will only count taxable income.  Individuals with seasonal income who may qualify for unemployment benefits during certain periods may include this income as long as it is consistent year over year. Underwriters also add back certain “non-cash” business expenses such as depreciation, which is not an actual cash expenditure. Again, the watchword is “taxable.” If income is not reported on an applicant’s return, it will not be counted in the underwriting process.
Self-employed borrowers routinely take advantage of allowable deductions to minimize tax liability, but remember that lower taxable income impacts the ability to qualify for a mortgage loan. It’s the proverbial “double-edged sword.” Consultation with a tax professional is recommended when weighing the cost-benefit of certain tax deductions.
Underwriters may evaluate the strength of a self-employed borrower’s business or profession as well, asking for business financial statements or even bank statements to verify consistent deposit activity. They also consider the prospect of the business’s viability for at least three years into the future, and they are alert to industries that are generally in decline or have been negatively impacted by the COVID-19 pandemic.
When couples apply for mortgages, one may be a W-2 employee while the other is self-employed. If the W-2 employee’s verified income is sufficient for loan approval, no worries!
However, if the self-employed borrower’s income is required to qualify, then all of the aforementioned scenarios apply.
Alternatives to standard, investment-grade home mortgages do exist. Some lenders offer in-house mortgage loans that may have relaxed qualifying criteria. Historically, lenders offered “bank statement” loans, allowing self-employed borrowers to qualify for mortgages based on bank statement information as income verification; however, these programs have virtually disappeared.
Obtaining a mortgage isn’t the most direct path for a self-employed borrower, but don’t be discouraged — you’re not alone. Recent statistics reveal that more than 10 million Americans are self-employed, and they share similar experiences. Preparation and understanding the process will make all the difference.

Borrower Be Prepared

If you are self-employed and plan to apply for a mortgage loan, the following documentation will help you qualify:  
  • At least two years of personal tax returns including all supporting schedules;
  • Two years of business tax returns including all supporting schedules, if applicable;
  • A current balance sheet and income statement, if these are routinely produced;
  • A copy of the business license, if available;
  • And a signed letter of confirmation from your accounting professional that the documents are true and correct to the best of their knowledge and your business is a going concern.

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