Self-employed mortgage documents: what lenders ask for

Are you self-employed in the lender's eyes?

Fannie Mae's Selling Guide says anyone with a 25% or greater ownership interest in a business is considered self-employed. That includes sole proprietors filing Schedule C, partners, and owners of S corporations and corporations who meet the threshold. If you own less than 25% and receive a W-2 or a K-1, you are generally treated as an employee for documentation purposes.

The history lenders want

Fannie Mae generally requires a two-year history of earnings to show the income is likely to continue. There is room on either side:

• Less than two years: income can still be considered if your most recent signed personal and business returns show a full 12 months from the current business, and you can document earlier income at the same or higher level in the same line of work or a role with similar responsibilities. The lender will weigh your experience and any debt the business has taken on.
• One year of returns: lenders may accept a single year of personal and business returns if the business has existed for five years and you have owned 25% or more of it for five consecutive years.

The documents

Expect to provide:

1. Personal federal tax returns for the past two years, signed, with all schedules. Lenders can use IRS transcripts instead when they are complete.
2. Business federal tax returns for partnerships, S corporations and corporations, usually for the same two years.
3. Proof the business is operating, such as a business license, a letter from your accountant, or a listing with a state agency.
4. Bank statements for the money you will use for the down payment and closing costs.

Fannie Mae's rules on document age mean your most recent returns matter. If you apply early in the year before filing, the lender may ask for the prior year's returns plus other evidence, or wait until you file.

How income is figured

Fannie Mae makes clear that business income reported on a personal return is not automatically money you received. Lenders must complete a cash flow analysis, using Fannie Mae's Form 1084 or a similar method, to determine income you can rely on. They look at:

• The stability of your income.
• The location and nature of the business and demand for what it sells.
• The financial strength of the business.
• Its ability to keep generating and distributing enough income for you to make the payments.

The analysis can add back some non-cash expenses, such as depreciation, and subtract items that reduce cash. The result is usually averaged over the years reviewed.

The final check before closing

Self-employed borrowers still get a final employment check. Fannie Mae's verbal verification rules say that for self-employment income, the lender must complete the verification no more than 120 calendar days before the note date, using a method suited to your business, and the documents must confirm the business exists. Keep your license current and your accountant reachable.

Preparing in the year before you apply

Your tax return is your pay stub. A few decisions before you file can make a real difference:

• Talk to your tax preparer about the trade-off. Write-offs lower your taxes, but they also lower the income a lender can count. You do not have to change how you file, but know the effect.
• Keep business and personal money separate. Clean accounts make the cash flow analysis and asset review easier.
• Avoid big swings. A sharp drop in the most recent year draws scrutiny. If you expect one, document the reason.
• Do not change structure right before applying. Switching from a sole proprietorship to a corporation can reset the history lenders review.
• File on time. Late or unfiled returns can stall an application.

Talking to lenders

Ask each lender how it handles self-employed income, which documents it needs up front and whether it can give you a preliminary income figure before you shop for homes. A preapproval based on your full returns is far more reliable than one based on what you say you earn.

The bottom line

Lenders qualify self-employed borrowers on the income their tax returns support after a cash flow analysis, usually averaged over two years. Gather two years of signed personal and business returns, proof the business operates and clean bank statements, explain any decline, and expect a final verification within 120 days of closing.