Mortgage Considerations for Self-Employed Borrowers

Who counts as self-employed for a mortgage?

For conventional loans backed by Fannie Mae, its Selling Guide treats anyone who owns 25 percent or more of a business as self-employed.

Fannie Mae notes that business income on your personal tax return, such as from a partnership or S corporation, may not have been paid out to you. So the lender looks at the business income that has been or could be paid to you while the business keeps running.

Sources: Fannie Mae, "Underwriting Factors and Documentation for a Self-Employed Borrower"; Consumer Financial Protection Bureau, "What is a Qualified Mortgage?"

What documents do lenders use to verify self-employed income?

Under Fannie Mae's rules, a lender can verify self-employed income with your signed federal tax returns for the past two years, with all schedules. In some cases, it needs your business returns too. It can use transcripts of those returns from the IRS instead.

Sometimes one year of personal and business tax returns is enough. Among other things, Fannie Mae requires that the business has existed for five years. You must also have owned 25 percent or more of it for the past five years in a row.

The lender also has to write up an analysis of your personal income, including business income or loss on your tax returns. The goal is to find the stable income you can count on. The lender can use Fannie Mae's cash flow form or another method that follows the same principles.

Source: Fannie Mae, "Underwriting Factors and Documentation for a Self-Employed Borrower"

How long do you need to be self-employed to get a mortgage?

Fannie Mae generally requires lenders to get a two-year history of your earnings. This shows the income is likely to continue. In some cases, a lender can still consider less than two years of self-employment.

For a shorter history, your latest signed personal and business tax returns must show a full year (12 months) of income from your current business. The loan file must also show you earned the same or more before. That earlier income must be from the same kind of business or a job with similar duties.

In those cases, the lender must look closely at your experience and at how much debt the business has taken on.

Source: Fannie Mae, "Underwriting Factors and Documentation for a Self-Employed Borrower"

What does a lender look at in a self-employed borrower's business?

Under Fannie Mae's rules, a lender looks at how stable your income is and at where your business is and what it does. It also looks at demand for what the business sells and at the business's financial strength. And it looks at whether the business can keep earning and paying out enough for you to make the loan payments.

When the lender needs business tax returns, it also writes up an analysis of the business's income. That analysis looks at year-to-year trends in gross income, expenses and taxable income.

If business money will pay for the down payment, closing costs or reserves, the lender must check that taking it out won't hurt the business.

Source: Fannie Mae, "Underwriting Factors and Documentation for a Self-Employed Borrower"

What does federal law require a lender to verify?

The federal ability-to-repay rule requires most lenders to make a reasonable, good faith decision that you can repay a mortgage before they make it. Lenders generally must find out, consider and document your income, assets, employment, credit history and monthly expenses.

The rule is part of the CFPB's Regulation Z. It says a lender must verify the income or assets it relies on with third-party records that give reasonably reliable evidence. Examples include tax returns, W-2 forms, payroll statements, financial institution records and records from your employer.

The CFPB says making a qualified mortgage is one way a lender can follow the ability-to-repay rule. A loan that isn't a qualified mortgage still has to meet the rule if the rule covers it. The rule lets each lender use its own underwriting definitions, as long as it meets the rule's requirements.

So a lender's own program may verify income with records other than tax returns, such as financial institution records, if they meet the rule. The rule's official interpretation also says a profit-and-loss statement you prepare counts as a third-party record if an outside accountant reviews it.

Sources: Consumer Financial Protection Bureau, "What is the ability-to-repay rule?"; eCFR, "12 CFR 1026.43, Minimum standards for transactions secured by a dwelling (Regulation Z)"; Consumer Financial Protection Bureau, "§ 1026.43 Minimum standards for transactions secured by a dwelling. (Regulation Z, with official interpretation)"