Who counts as self-employed?
For a conventional loan under Fannie Mae’s rules, you’re self-employed if you own 25% or more of a business. That includes sole proprietors, partners, LLC owners, and S corp or C corp owners at that level.
The rules below are Fannie Mae’s for conventional loans. FHA, VA and other programs have their own. The idea is the same, but details differ.
How much history do I need?
Generally two years of self-employment.
Less can work. Fannie Mae allows a shorter history if your most recent signed personal and business tax returns show a full 12 months of income from your current business, and you have a prior history of earning similar or more in the same field. For example, you were a W-2 electrician for years, then started your own electrical company.
Under 12 months on a return is a harder case. Talk to me.
Which documents will I need?
Usually:
- Two years of signed personal tax returns, all schedules.
- Two years of business tax returns for partnerships and corporations, in many cases.
- Or IRS transcripts in place of the returns, in some cases.
There are two ways the list can get shorter under Fannie Mae’s rules:
- One year of returns can be enough if the business has existed at least five years and you’ve owned at least 25% of it for five years in a row. The lender also has to do a written cash flow analysis.
- Business returns can be waived in some cases, if you’re using personal funds for the down payment, closing costs and reserves, you’ve been self-employed in the same business for five years, and the personal returns show the business income going up.
I’ll tell you exactly which ones your file needs.
How is the income actually calculated?
The lender doesn’t use your gross sales or deposits. For a conventional loan, the starting point is what’s on your returns after expenses. Then the lender adjusts it.
Fannie Mae has the lender do a written analysis of your income. Lenders can use Fannie Mae’s Cash Flow Analysis, Form 1084, or a tool that follows the same principles.
What gets added back
For a sole proprietor on Schedule C, Fannie Mae’s rules say these recurring items get added back to your income:
- depreciation
- depletion
- business use of your home
- amortization
- casualty losses
These are expenses on paper that don’t come out of your pocket every year, or aren’t expected to recur. Adding them back can help.
What gets taken out
Income that won’t repeat gets deducted. Fannie Mae’s rules give an example: income on Schedule C that didn’t come from the business’s profits. The lender also deducts the meals and entertainment exclusion reported on Schedule C.
Partnerships and S corps
If you own a partnership or S corp, the income on your K-1 may not be what you actually took home. Fannie Mae’s rules have the lender look at what was distributed to you, or confirm the business has enough money to support it. Business returns usually come into play here.
What if my income went down?
The lender looks at the trend, not just the average. Fannie Mae offers Form 1088 for comparing year over year.
Fannie Mae’s rules have the lender look at year-to-year trends in the business’s gross income, expenses and taxable income, plus the stability of your income, the demand for what you sell, and the financial strength of the business. Steady or rising income is easier to work with. A lower year means more questions about why and whether the business is still on solid ground.
If you know a year dipped and why, tell me early. A one-time reason with a clear explanation is a different story from a steady slide.
Can I use business money for my down payment?
Sometimes. Fannie Mae’s rules have the lender do a business cash flow analysis to make sure taking the money out won’t hurt the business. The lender may ask for several months of recent business account statements or a current balance sheet.
What if my tax returns undersell what I make?
Good write-offs lower your taxes. They also lower the income a lender can use from your returns.
If the returns don’t show enough, two paths to look at:
- A bank statement loan. It uses your bank deposits instead of your tax returns.
- Other non-QM loans. These are loans outside the standard rules, for cases where a regular loan doesn’t fit.
They work differently than a conventional loan, with different terms and costs. I’ll show you both side by side so you can decide.
What should I do before I apply?
- File your returns on time, and sign them.
- Keep your business and personal accounts separate.
- If you’re planning to buy in the next year or two, talk to your CPA about how your write-offs will show up on your returns. I’m not a tax advisor, and this isn’t tax advice.
- Send me your last two years of returns. I can tell you pretty quickly what a conventional lender will see.
Questions about your income? Call me at 817-873-6288.