When you apply for a mortgage, the lender will check your monthly income to make sure you can afford to make regular house payments.
For some borrowers, monthly income isn’t easy to calculate.
Freelancers, business owners, and other independent contractors are considered “self-employed.” Their income is determined by profit-and-loss statements, 1099s, and tax returns.
Fortunately, that won’t exclude you from getting a mortgage. It’s possible to get approved with self-employed income as long as you know what lenders are looking for.
How is self-employment income calculated for a mortgage?
This article will show you how to calculate your self-employment income just like lenders do. That way you’ll know whether you can buy or refinance a property.
In this article:
- Two-year self-employed minimum
- Are you self-employed? You might be if…
- Required self-employed documentation
- What types of self-employed income do lenders look for?
- Do mortgage lenders use gross or net income?
- Self-employed mortgage loan options
- Home loan alternatives for self-employed borrowers
- What are mortgage lenders looking for with self-employed borrowers?
- Mortgage qualifying tips for self-employed borrowers
- Tax return issues for self-employed borrowers
- Calculating self-employed income
- Our recommended lenders for self-employed borrowers
Before calculating your income, a lender will make sure you’ve been in business, in a self-employed capacity, for at least two years.
How do you prove that? You can provide a copy of your business license, but lenders will also want to see two years of federal filed income taxes, signed and dated.
Lenders define a self-employed borrower as anyone who receives more than 25 percent of their income in non-salaried pay. This definition incorporates borrowers who work on commission or earn bonuses along with a regular salary.
Will your mortgage lender consider you self-employed? The answer is yes if:
- You’re a sole proprietor
- You own your own business
- You are a partner with at least 25% ownership in a business
- You receive more than 25% of your income in bonus or commission income
- You are a contract worker, even if you work for only one company
- You receive 1099 forms instead of W2s
- You pay self-employment tax payments
- The bulk of your income comes from dividends and interest
- You are primarily a landlord
- You receive royalties
Let’s be clear: Self-employed people can still get mortgage loans. But they may have to provide some extra income documentation compared to someone with two years worth of W2 forms from an employer.
Self-employed business structures
A wide variety of business structures fit the description of “self-employment” from a lender’s point of view. And mortgage underwriters will look at each self-employment structure differently.
Here are some common business structures.
- Sole proprietorship: One person owns and controls the business. Income is reported on Schedule C of your personal income tax return. An example would be the single owner of a landscaping company. Generally, sole proprietorships are smaller companies
- Partnership: Two or more people own and control the business. Profits from the business are split between the owners
- Corporations: Stockholders own the business. Usually these are larger companies. A borrower who is 25 percent owner of a corporation is pretty rare to see on a mortgage application, but it happens. Getting the corporate tax returns can be difficult, since many parties may be involved in releasing them
- S Corporations: This is a corporation with a limited number of stockholders. If you are the owner of an S Corp, you’ll need to supply your 1120S tax return to your lender.
IRS tax return schedules for self-employed borrowers
Along with personal 1040 tax forms, lenders may ask self-employed loan applicants for the following schedules:
- Schedule C: Reports income or loss from a sole proprietorship
- Schedule D: Reports income from capital gains or losses. This type of income comes from the sale of stock or real estate. Usually, these are one-time events and can’t be counted toward ongoing income. However, day traders and property flippers may be able to use schedule D income if they prove it has been steady for three years
- Schedule E: Income and loss from leased and rented real estate is reported on this form. Borrowers who maintain a full-time job while owning rental properties will have net income or loss from schedule E. The lender will add or subtract this income from their employment income. Depreciation claimed on the schedule E can typically be added back to the borrower’s income.
- Schedule F: This schedule is used for farming income.
Your tax preparation software — or your professional tax preparer — can provide these forms if you don’t already have them.
If you are a self-employed person applying for a mortgage, you will have to hand over more documents than a salaried or wage-earning employee would.
Depending on your personal finances, you’ll need to provide some of these extra documents:
- Personal income tax forms: This includes two years’ personal tax returns (IRS form 1040) along with all schedules you were required to file, including Schedule SE
- Proof of income: 1099 forms and/or W2s from your small business if you pay yourself a salary
- Business tax forms: These include K1s and forms 1120 and 1120S, if you were required to file those
- Profit-and-loss statement: This shows the current year’s finances and how they compare to previous years’ tax records
- Current clients: This list helps lenders see you’re still earning the income reflected in tax statements
- CPA letter: This shows you are still running your self-employed business
- Explanation letter: To explain irregularities — such as receiving most of your income at a specific time of year. Otherwise, the lender may think your profit-and-loss statement is off track compared to previous years’ income
If you are part of a business that has many owners, make sure all controlling parties agree that you can have access to business tax returns and can turn them over to a lender.
Lenders will want to know all about your income when you apply for a mortgage. For most home buyers, “income” means money earned from work, and sharing income should be simple enough.
But lenders will consider any source of income that’s steady and reliable, including disability benefits, child support payments, and — for self-employed borrowers — income from a variety of sources.
Income sources for self-employed borrowers could include:
- Fees earned through gig work such as making deliveries
- Fees earned through freelance work
- Consulting fees
- Money earned in a seasonal job
- Revenue from a business
- Rents from investment properties
To count as “income” in your lender’s eyes, any source of income will need to be continuing — not a one-time payment or income from a contract that has expired.
For taxpayers who earn wages or a salary, mortgage lenders typically look at gross income. That’s your income before state and federal income tax deductions, health insurance premiums, and Social Security or Medicare taxes.
It’s different for self-employed borrowers. Self-employed taxpayers usually reduce their tax liability by writing off work-related expenses: travel expenses, subscriptions, rents, etc.
This method saves money at tax time by lowering taxable income. But it can also have a negative effect on mortgage eligibility.
From a lender’s point of view, a lower taxable income just looks like a lower income. A lower income raises the debt-to-income ratio — one of the key factors lenders check.
Just like any other home buyer, self-employed buyers have four main options for a home loan:
Most mortgage borrowers get conventional, conforming loans. Fannie Mae and Freddie Mac, which are government-sponsored enterprises, set the guidelines for these loans.
For self-employed borrowers, conforming lenders will look for two years of self-employment history, though one year may be enough if you can show you’ve earned a similar income in a similar field for at least two years before you became self-employed.
Conventional loans do not come with insurance from the federal government, unlike FHA, USDA, and VA loans, so lenders will rely more on your credit score, debt load and down payment size.
- A FICO score of at least 620
- A debt-to-income ratio below 43 percent in most cases
- A 3 percent down payment
To get more competitive interest rates, you’ll likely need to surpass these limits.
Self-employment rules for FHA loans look a lot like conventional loan requirements. It’s best to have at least two years of successful self-employment history.
You could get approved for an FHA loan with only one year of self-employment history if your previous work experience was in the same field. It also helps if you have degrees or certifications to show you’re qualified for your profession.
FHA loans come with a big advantage for borrowers with lower credit scores: built-in mortgage insurance from the Federal Housing Administration. This insurance protects the lender, allowing lower mortgage rates despite a lower credit score and minimum down payment.
To get approved, you’ll need:
- A FICO score of at least 580
- A debt-to-income ratio below 50 percent
- A 3.5% down payment
It’s possible to find an FHA lender willing to approve a loan even if your credit score falls as low as 500, but the lender would require a 10 percent down payment instead of the usual 3.5 percent.
FHA loans finance only primary residences, and they require the borrower to pay mortgage insurance premiums, adding an upfront fee as well as annual fees.
USDA loans offer a great deal — competitive interest rates, low mortgage insurance premiums and no down payment required — but only to home buyers with moderate income in rural and suburban areas.
Self-employed borrowers who meet the USDA’s eligibility requirements will need to show a two-year history of earnings.
Borrowers with only one year of self-employment history can get approved by showing they were employed in a similar field for at least two years before their self-employment started.
USDA-guaranteed loans require:
- A FICO score of 640 or higher
- Income that does not exceed 115% of your area’s median income
- No down payment required
Only veterans, active-duty military members and some surviving spouses of veterans can use the VA home loan program. If you’re eligible, a VA loan is likely your best deal.
These loans require no money down and no mortgage insurance. The VA does not impose loan limits, and the VA’s guarantee to lenders allows them to lower mortgage rates.
Self-employed borrowers can get approved by showing two years of self-employment history. If you have at least one year of self-employment, you can still get approved by showing you worked in a similar field for at least two years before becoming self-employed.
VA loans finance only primary residences.
Most home buyers who are self-employed use the same types of mortgages as everyone else. What’s different is the way self-employed borrowers document their income.
But self-employed people often write off expenses at tax time, lowering their adjusted gross income. If your net earnings aren’t high enough to qualify for the mortgage you need, you may have another option.
A bank statement loan could help solve your problem. These loans rely on deposits into your bank, instead of tax forms, to show your income.
But these loans have higher interest rates because they’re riskier for lenders — they don’t conform to Freddie Mac and Fannie Mae rules.
Other options: Apply with a co-borrower who is not self-employed. Or start a conversation with your loan officer about the inaccuracies in your earned income.
No matter how a borrower gets paid, a mortgage lender wants to know the same thing: Will this borrower be able to make regular loan payments for the foreseeable future?
Self-employment presents a challenge to mortgage underwriters, but it shouldn’t be a deal-breaker — it’ll just require more questions from the lender.
If the borrower can answer the lender’s questions, showing the lender that the income has been reliable for at least two years — and that the income should continue for at least three more years — the lender should be satisfied.
It’ll also ease the lender’s worries if the borrower has a strong credit profile and a low debt-to-income ratio.
Self-employment can complicate the home buying process. If possible, avoid complicating your application in other areas. Be sure to:
Check your DTI ratio
The lower your monthly bills in relation to your earned income, the stronger your mortgage application will look.
Different lenders and loan types have different rules but shoot for a ratio that’s less than 36 percent of your adjusted gross income. You can do this by paying off a few loans and lowering your credit card balances.
Monitor your credit
Your monthly income shows your ability to repay a loan; your credit score shows your willingness to repay it based on your recent financial habits.
Minimum credit scores for mortgages tend to range from 580 to 640. But getting your score above 720 will strengthen your application a lot.
Just like with DTI, paying down some debt and making regular, on-time payments will help. Also, be sure to check your credit reports for errors that could be pulling down your score.
Keep business expenses separate
As a small business owner, your personal and business finances may be intertwined. If so, your mortgage lender will have a harder time distinguishing your money from your business’s money.
If possible, in the two years before applying for a mortgage, change your financial habits to keep your personal and business finances separate. A certified public accountant can help.
Several issues can trip up a self-employed borrower when applying for a home loan and providing tax returns to the lender. Here are some of the most common:
A lender will consider what a business made in net earnings, not gross profit. For instance, a pet shop owner pulled in $80,000 last year in revenue. Not bad, right?
But the business also had to pay rent, supplies, utilities and insurance to the tune of $30,000 last year. So a lender will only consider $50,000 in profit as real income.
If your business makes $100,000 but you write off $90,000, guess how much the lender will say you made? Yep, $10,000 or just $833 per month. And you can’t qualify for much house with that.
Writing off legitimate business expenses is a wise move yet there are occasions where there are so many write-offs the business appears to make no money at all. If you plan to apply for a mortgage in the next three to four years, don’t go overboard on your write-offs.
Your side business
Many people work full time, yet have a side business, for which they file Schedule C on their tax returns.
Note that if you plan not to disclose your side business for whatever reason, your lender will find out about it anyway. The lender will pull transcripts (called 4506 transcripts) directly from the IRS which will show income or loss from a Schedule C business.
When you apply for the mortgage, be sure to tell your loan officer about your side business, and how much it made or lost during the last two years.
Many side business owners simply have a side business to write off expenses. If this is you, keep in mind that the lender will count your business loss against you.
For instance, if your tax returns show that you lost $12,000 in the prior year, your lender will reduce your qualifying current monthly income by $1,000.
Unlike positive business income, you don’t have to have the business for two years for it to count against you. If you just opened your side business, a loss for just one year will need to be considered.
If you closed your business after filing the previous year’s tax return, it’s possible for the underwriter to disregard the business loss. Write a letter saying how, why, and when you closed the business, and provide any documentation backing up the business closure.
Even if you’re not self-employed, you can claim unreimbursed business expenses including mileage. You claim these on form 2106. These deductions are counted against your total W2 income.
An example of employee business expenses are tools and supplies not provided by the company, non-reimbursed mileage to work-related meetings, and cell phone charges if you use your personal cell phone for work.
Two-year self-employed average income
When a lender reviews business income, they look at not just the most recent year, but a two-year period. They calculate your income by adding it up and dividing by 24 (months).
For example, say year one the business income is $80,000 and year two $83,000. The income used for qualifying purposes is $80,000 + $83,000 = $163,000 — then divided by 24. That shows a monthly income of $6,791 per month.
Declining self-employed income
But the lender also looks at something else when reviewing years one and two: consistency.
The example above showed consistent income from year to year. What if the income looked more like this:
- Year 1: $80,000
- Year 2: $40,000
When you calculate a monthly income with these numbers, the amount is $5,000 per month.
A lender probably won’t approve this loan. Why? Because there is a serious decline in income and could indicate a failing business.
Part of the income review process is determining the likelihood the income will continue. A business with declining income looks like a business that might not survive three more years.
In fact, lenders will typically make a loan determination based on the worst year’s income.
However, there is no hard-and-fast rule regarding a specific decline in income. It’s up to the judgment of the underwriter approving the loan. A slight variance of say $80,000 to $70,000 might raise some questions but with a proper explanation, the application will still be approved.
There may be a legitimate reason for the lower income. The business owner took some time off to take care of a new baby. This easy-to-document occurrence can show why the income took a slight dip. In this instance, the underwriter might ask for three years’ tax returns instead of just two.
A lender will also look at bank statements to examine the cash flow of the business. Is there enough monthly income to service debt? Some businesses rely on daily purchases of their goods and services such as a café or retail store. Others rely on just a few transactions per year.
When reviewing income, a lender wants to make sure there are enough funds in an account to pay the bills.
Using business accounts for your down payment and closing costs
In some cases, you can use funds from your business accounts from your down payment.
Sometimes, though, the underwriter will ask you for a letter from your certified public accountant (CPA) saying that taking money from the business won’t jeopardize the ongoing health of the business.
Your CPA may or may not be willing to write this letter.
The underwriter wants to verify your business won’t be short on cash and be forced to take out loans or shut its doors due to lack of funds. After all, your business is the source of your income, and if your income stream stops, you may default on your loan.
Any business funds used for closing costs or the down payment on a home should be excess money that the business will not need for the foreseeable future.
If you’re self-employed, you may disagree with the final income the underwriter determines for you. This is a common feeling experienced by many self-employed home buyers.
Self-employed income calculations can sometimes boil down to judgment calls by the underwriter, especially for borrowers who have multiple businesses or properties, or whose business ventures are a bit outside the box.
If there’s any doubt about how much the underwriter will calculate in your case, give your tax returns to a mortgage professional for review.
Also, most lenders offer an underwriter income review for more complicated tax returns, sometimes even before you officially apply for the mortgage.
This review gives everyone involved a starting point since the underwriter comes up with qualifying income ahead of time.
How to calculate self-employment income FAQs
How is self-employment income calculated?
Self-employed individuals typically submit income tax forms to document their income for a mortgage loan. The lender will then average income over the past two years and divide that annual income by 12 to come up with an average monthly income.
How do I calculate my gross monthly income for self-employment?
Add up all your income for the previous two years and then divide that number by 24 to see your gross monthly income. To count as income for your lender, your income should come from a source that’s at least two years old — and you should have proof you expect the income to continue at least three more years.
Can I calculate self-employment income from my tax returns?
Yes. You can check Line 11 of your 2021 1040 tax form to see your adjusted gross income. (Online software like TurboTax can also show your AGI.) Then, divide your AGI by 12 to see your monthly income.
How do I calculate gross annual income for self-employment?
Adjusted gross income shows your net profits from self-employment. That is, it’s your income after expenses. If you’ve filed taxes for the previous year, you have already calculated adjusted gross income. It’s on Line 11 of the 2021 1040.
Do I have to report self-employed income?
Yes, you should report self-employment income to your lender. If you’re self-employed but you earn most of your income from a salaried or wage-earning job, you may not need to apply as a self-employed borrower. However, to use your self-employment income to qualify for your loan, you’ll still need to provide tax forms and other documents.
Can you get a joint mortgage if one person is self-employed?
Yes. You can get a joint mortgage with one self-employed and one W-2 borrower on the application.
Most lenders work with self-employed borrowers. Once you’ve documented your income, the rest of your borrowing experience shouldn’t be much different from anyone else’s. Be sure to get quotes from at least three lenders since pricing — for both fees and rates — can differ a lot from lender to lender.
Is it harder to get a mortgage when you’re self-employed?
A self-employed borrower faces more scrutiny than the standard paystub/W2 employee.
If you go into your loan application with the proper expectations, you’ll close your mortgage loan with very few surprises.