Before you get approved for a mortgage, lenders need to know that you can afford it. If you work for someone and get a W-2, it’s easy for lenders to calculate your income. You can even do it, by just dividing your income by 12 months. But, if you work for yourself, there’s a whole different aspect that comes into play.
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Keep reading to learn how to calculate your self-employment income to see if you may qualify for a mortgage.
You Need a Two Year History
First, know that you need a two-year history. Lenders need this for two reasons:
- Two years is a good amount of time to see if you’ll succeed in the business. Anything less and your ability to succeed is still up in the air.
- Two years gives time to account for the ups and downs your income will likely go through, especially if you are a seasonal business.
Proving Your Self-Employment Income
If you have the two-year history, you then have to prove your income. Lenders will ask for your latest paystubs (if you pay yourself) as well as your tax returns for the last two years. They will also need to see a current YTD Profit and Loss Statement.
Now, you can calculate your self-employment income by taking the income reported on Schedule C of your tax returns and dividing it by 12. Keep in mind that Schedule C takes into account the expenses you write off on your taxes. The number you come up with may surprise you because it may be much lower than you anticipated.
Lenders must take the number that you claim on your tax return. If you report a loss on your tax returns, that’s what lenders use. While you likely have expenses you want to deduct, keep this in mind as you think about buying a home. It may be best to lay off the deductions until you get your mortgage and then you can go back to taking the deductions the IRS allows.
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Your Bank Statements Must Match
Keep in mind that your bank statements must also match what you state on your application. Lenders need to see that you actually receive the money that you claim you receive. As a part of the process, lenders will verify your assets to determine their origination, especially if you use the funds for your down payment or to cover the closing costs. If you have large deposits in your bank account, don’t assume you can include them as a part of your income. Instead, lenders will need to investigate where the funds came from to ensure that the funds belong to you. In most cases, they won’t use the funds as a part of your income, though.
The Profit and Loss Statement
We mentioned above that lenders will also require a Profit and Loss Statement. This helps lenders know that you are on track to make the same amount of money they calculated using your tax returns. For example, if your two-year average shows that you make $5,000 a month, but your current P&L only shows you on track to make $3,000 per month this year, it may give the lender reason to pause.
The lender may ask for clarification on the reason for the lower P&L. If you have proof of the lower income and its reason is valid, the lender may let it go. But, if it’s truly just a decrease in sales, the lender may use the lower income to qualify you for the loan so that they don’t approve you for more loan than you can afford.
Use caution when applying for a mortgage as a self-employed borrower. You’ll need to solidify your qualifying factors including your credit score and the amount you have for a down payment. The more positive factors you can provide a lender, the easier it will be to get a loan as a self-employed borrower.
