Self-employed mortgage borrower? Here are the rules

Self-employed mortgage loans are common

Self-employed mortgage borrowers can apply for all the same loans “traditionally” employed borrowers can.

There are no extra requirements for self-employed mortgage loans. You’re held to the same standards for credit, debt, down payment, and income as other applicants.

The part that can be tough is documenting your income. Proving your cash flow as a business owner, contractor, freelancer, or gig worker can require more paperwork than for W-2 employees.

But as long as you meet loan guidelines and can document steady, reliable cash flow, being self-employed should not stop you from buying a home or refinancing.

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Self-employed mortgage rules

Most mortgage lenders require at least two years of steady self-employment before you can qualify for a home loan. Lenders define “self-employed” as a borrower who has an ownership interest of 25% or more in a business, or one who is not a W-2 employee.

However, there are exceptions to the two-year rule.

You might qualify with just one year of self-employment if you can show a two-year track record in a similar line of work. You’ll need to document an equal or greater income in the new role compared to the W2 position.

Some lenders will even count one year of related employment, plus one year of formal education or training, as an acceptable work history.

If you’ve been self-employed for less than one year, you’re not likely to qualify for a home loan.

Loan program requirements

In addition to proving their employment history, self-employed borrowers need to meet standard loan program requirements.

Guidelines vary by loan type (more on this below). But in general, you should expect a lender to look at the following criteria in addition to your employment and income:

• Credit score
• Credit history
• Current debts (for your debt-to-income ratio)
• Liquid savings and assets (for your down payment and closing costs)

Lenders will scrutinize both the property you want and your personal finances.

The type of property (house, condo, etc.) and the intended use (primary residence, vacation home, investment property) will have an impact on the types of mortgage loans you qualify for as well as your interest rate.

What types of income do mortgage companies look at for self-employed borrowers?

Mortgage lenders will generally consider any source of steady income that is “stable, consistent, and ongoing.”

That means all kinds of self-employment income are eligible for mortgage financing, including (but not limited to):

• Business owners
• Freelance income
• Contract work
• Seasonal work
• Gig work and side jobs

These types of income can be considered on their own, or as additional funds on top of a primary income source.

Lenders will sometimes even count unemployment income for contract or seasonal workers with a regular, documented history of receiving unemployment in the off-season.

For any source of income, your loan officer must determine it will be “ongoing.”

Generally, this means the income seems likely to continue for at least three years after loan closing. So your business prospects need to look good. A history of declining income will not improve your chances with a mortgage lender.

For self-employed borrowers, a loan officer may conduct a review of the borrower’s business to determine its stability and the likelihood their income will continue at the same level.

If you’re in a declining industry — such as a hotel owner during the coronavirus pandemic or a builder during a housing crash — this could pose problems with your approval.

Mortgage lenders only count taxable income

If you hope to buy a house or refinance while self-employed, this point is key: Lenders only count taxable income toward your mortgage.

Underwriters use a somewhat complicated formula to come up with “qualifying” income for self-employed borrowers. They start with your taxable income, and add back certain deductions like depreciation, since that is not an actual expense that comes out of your bank account.

Business owners and other self-employed workers often take as many deductions as they can. While this can save you a lot of money with income tax, it can also hurt you when it comes to your mortgage application.

For instance, say you earn $6,000 a month. But after deductions, your taxable income is only $4,000 per month. Here’s how your home buying budget changes:

Monthly Income	$6,000 (total)	$4,000 (taxable)
30-Year Fixed Interest Rate	3.5%	3.5%
Current Monthly Debts	$300	$300
Down Payment	$40,000	$40,000
Maximum Home Price*	$407,800	$250,000

*Example assumes a maximum debt-to-income ratio of 36%

In this example, losing $2,000 off your monthly income reduces your home buying budget by more than $150,000.

Bank statement loans

Some self-employed borrowers get around this issue by using a type of mortgage called a bank statement loan, which lets you qualify based on total funds coming into your bank rather than income tax returns.

“Bank statement loans can be useful for buyers who don’t have the 1-2 years of returns to verify income,” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO.

However, bank statement loans are considered non-qualified (non-QM) mortgages. This means they lack some of the consumer protections of major loan programs and have higher interest rates.

The majority of self-employed borrowers stick to mainstream loan programs with lower interest rates, even though their loan amount may be smaller.

Documenting self-employed income

In most cases, self-employed borrowers need to provide the following documents to prove their income to a mortgage lender:

• Two years of personal income tax returns
• Two years of business tax returns including schedules K-1, 1120, 1120S
• Business license
• Year-to-date profit and loss statement (P&L)
• Balance sheet

These documents can be prepared by a Certified Public Accountant (CPA), accountant, or tax preparer. Tax professionals are accustomed to these requests for a mortgage loan application. Your CPA may even be able to email you all your required documentation the same day.

In addition to the documents required for conventional financing, home buyers who are applying for a jumbo loan often need to provide a signed CPA letter stating you are still in business.

If the business is a sole proprietorship — not a partnership, corporation, or S corporation — you may not have to provide business tax returns.

If you’ve been self-employed at the same business for 5 years or more, you may only have to provide one year of business and/or individual tax returns instead of two.

Finally, for self-employed borrowers with a history of paying themselves, mortgage guidelines as of June 2016 state that the borrower no longer needs to prove access to the business income.

The applicant, however, may still need to show that the business earns enough to support income withdrawals.

Income inconsistencies

If your income is not regular and reliable, lenders generally won’t count it.

However, many businesses go through ups and downs. For instance, a home developer starting a new community might have a lot of expenses one year, buying property, pulling permits and constructing houses. The business may show little income or even big losses.

The next year, though, the houses sell and the income soars. If you submit a loan application during the “down” year, you’ll have to prove to the lender that your business is healthy and that this is a normal pattern.

In cases like this, your loan officer might require more than two years’ worth of tax returns to prove you have steady income. Expect to give the underwriters three, four, or five years of tax forms and a statement from your accountant to show this.

You should also prepare to explain any significant year-over-year decrease in income when you apply for a mortgage as a self-employed borrower.

Do I have to report self-employed income?

If you have a self-employed side gig — for instance, if you’re a W-2 employee but you drive rideshare or freelance for some extra cash — you might not have to report self-employment income to your lender.

Fannie Mae and Freddie Mac say that for conventional loans, self-employed income does not need to be reported if it’s not used to qualify for the mortgage.

In other words, if you can qualify based on W-2 income and personal savings alone — not using funds in a business account — then your lender can ignore the self-employment income and you don’t need to document it.

This provision applies to borrowers living off retirement income, social security income, pension payments, and/or dividends as well.

Note that these rules apply to conforming (Fannie Mae and Freddie Mac) home loans. Guidelines for other loans may be different

How is self-employed income calculated for a mortgage?

To calculate self-employed income during the mortgage process, lenders typically average your income over the past two years and break it down by month.

“Loan officers will use the worst case scenario,” says Meyer. “So if you made less in the most recent year, we will use a 12-month average, and if increasing year-over-year, then a 2-year average.”

For example, say your tax returns for the past two years show an income of $65,000 and $75,000. Here’s how a lender would calculate your monthly income for qualifying purposes.

• Year one: $65,000
• Year two: $75,000
• Average yearly income: $70,000 ($65K + $75K / 2)
• Monthly income: $5,830 ($70K / 12)

This calculation shows the lender you have $5,830 per month to spend on housing and other expenses.

How DTI affects your mortgage application

Underwriters don’t look at income in a vacuum. They look at it in the context of your existing debts. This is known as your debt-to-income ratio or DTI.

DTI measures your current, ongoing debts — like credit cards, auto loans, and student loans — against your gross monthly income. Lenders subtract your current debts to see how much money is ‘left over’ each month for mortgage payments.

Lenders often prefer a DTI below 45%. In the example above, that means no more than $2,620 can go toward debt payments each month — including your mortgage.

Say you already pay $500 each month toward a car loan and credit cards. Here’s how a lender uses that DTI number to calculate your home buying budget:

• Monthly income: $5,830
• Maximum DTI: 45%
• Max. total debt payments: $2,620 (0.45 x $5,830)
• Existing debts: $500/month
• Max. mortgage payment: $2,120 ($2,620 – $500)

That $2,120 monthly budget will get you a much lower loan amount than the full $5,830 monthly income. That’s why borrowers should be aware of their debt-to-income ratio when budgeting for homeownership.

DTI may be doubly important for self-employed borrowers, since large tax write-offs can lower your income in a lender’s eyes. So existing debts will take up a larger share of your approved budget.

If you anticipate this issue, it may be worth trying to pay some current debts down before you apply for a home loan.

Self-employed mortgage loan options

All the main mortgage programs are open to self-employed borrowers, including conforming loans (those backed by Fannie Mae and Freddie Mac) and government-backed FHA, VA, and USDA loans.

Briefly, here’s how your loan options compare.

Conventional loans for self-employed

Conventional, conforming loans are mortgages eligible for purchase by Fannie Mae or Freddie Mac. The majority of U.S. mortgages are conforming loans.

Fannie Mae and Freddie Mac will qualify self-employed borrowers after at least two years of self-employment — or, with at least one year of self-employment, plus a documented history of at least two years earning comparable income in a comparable role.

Aside from these guidelines, conforming loans require:

• 620 minimum credit score
• 3% minimum down payment
• Debt-to-income ratio below 45%, in most cases
• Loan amount within conforming loan limits

If your credit report reveals good credit and you have a moderate to large down payment (10-20%), a conventional mortgage is often the most affordable option.

Home buyers who put at least 20% down can avoid private mortgage insurance (PMI) on these loans. The same goes for homeowners who refinance with at least 20% home equity. Avoiding PMI can save you a lot compared to, say, an FHA mortgage.

FHA loans for self-employed

FHA mortgages are insured by the Federal Housing Administration. These loans are often best for low-credit and first-time home buyers because they have more lenient requirements.

To qualify for FHA financing, you need only a:

• 580 credit score or higher
• 3.5% down payment
• DTI below 50% (varies by lender)
• Plan to use the property as your primary residence
• Loan amount within current FHA loan limits

For self-employed borrowers, FHA also requires a two-year self-employment history — or one year of self-employment, plus two years in a related role with similar income. If you have one year in a similar role and one year of formal training or education, FHA may count this as an acceptable two-year history.

FHA typically requires two years of personal and business tax returns to document self-employment income.

However, you may not have to show business tax returns if:

• Your personal returns show increasing income over the past two years
• Down payment and closing costs are not coming from a business account
• Your loan is not a cash-out refinance

VA loans for self-employed

VA loans, guaranteed by the Department of Veterans Affairs, are meant for veterans, service members, and some surviving spouses. They have ultra-low interest rates and no ongoing mortgage insurance.

Requirements for VA mortgages are also fairly lenient. As a self-employed borrower, you’ll need at least two years in your current role, or one year of self-employment plus a two-year related work history.

Other requirements include:

A VA mortgage should always be the first stop if you’re eligible, since it’s typically the lowest-cost home loan on the market.

USDA loans for self-employed

USDA loans are mortgages guaranteed by the U.S. Department of Agriculture. These home loans require no down payment and tend to have below-market rates.

To qualify for USDA financing, you must have low-to-moderate income and live in a qualified ‘rural area.’ Self-employed applicants need a two-year history in their current role, or at least one year of self-employment and two prior years in a related role.

Other requirements for a USDA mortgage include:

• 640 credit score or higher
• 0% down payment
• Income no higher than 15% above the area median
• Property is a single-family residence
• You use a 30-year, fixed-rate mortgage

The rural requirement for a USDA mortgage might sound restrictive. But actually, the majority of the U.S. landmass qualifies as rural under USDA’s definition. So if this type of loan appeals to you, it’s worth asking a lender whether you and your home qualify.

Alternatives home loans for self-employed applicants

Self-employed mortgage loans have gained a reputation of being difficult since the housing downturn.

That’s because many self-employed borrowers don’t show enough income, if the lender’s definition of “income” is the bottom line on your tax return. And the old “stated income” or “no income verification” loans these borrowers used in the past have disappeared.

However, alternative programs allow you to count all of your business cash flow (the amount you actually bring in) as income. These are often called “bank statement” programs.

Under these guidelines, you bring in 12 or 24 months of your business and/or personal bank statements. Lenders analyze the cash going in each month, average it, and use that amount (or some formula based on that amount) to come up with qualifying income.

Note that these programs usually come with higher mortgage rates than mainstream loans, because they’re considered non-QM and therefore riskier to lenders.

Bank statement loans can also be harder to find, as mainstream lenders often don’t offer them. But there are plenty of specialized and non-QM lenders that do.

Am I self-employed?

You don’t have to own your own business to be considered self-employed.

A loan officer will likely consider you self-employed if any of the following apply:

• You own 25% or more of a business
• You do not receive W-2 tax forms
• You receive 1099 tax forms
• You are a contractor or freelancer
• At least 25% of your income is from self-employment
• Most of your income is from dividends and interest

If you’re part owner of a business but your share is less than 25%, you are not considered self-employed for home loan purposes.

And remember you are not required to report self-employed income under Fannie Mae and Freddie Mac’s lending rules.

If you have a freelance job or small business on the side, and you don’t need the income from it to qualify, your lender can ignore it on your mortgage application.

Can you get a joint mortgage if one person is self-employed?

Maybe you want to apply with a spouse or co-borrower, but one of you is self-employed and the other is traditionally employed.

Most mortgage lenders will be fine with this, provided the self-employment income meets the guidelines listed above and both applicants meet loan requirements.

You also have the option not to count your co-borrower’s income source if you wish.

If you qualify for a loan with your own income, and your co-borrower is self-employed, lenders can ignore that business in underwriting.

Why would you want them to ignore that business? Because many small ventures, or even larger start-ups, don’t show income on tax returns. At least on paper, they generate losses.

While these business write-offs are great for reducing taxes, they can reduce your qualifying (taxable) income when you apply for home financing.

What’s the best lender for self-employed mortgages?

Self-employed borrowers don’t have to hunt for specialized lenders. Just about any mortgage company can approve your application with self-employment income.

That means you have the flexibility to shop around for the loan type you want and a low interest rate.

Keep in mind, almost every lender will calculate your income based on tax returns. So the amount you earn could look lower than it actually is.

If you want to qualify based on bank statements rather than tax returns, it’s possible, but these lenders are harder to find and charge higher interest rates. See our list of bank statement lenders here.

Most self-employed borrowers go the mainstream route and apply for a conventional or government-backed loan with a major lender. This allows you to shop around and take advantage of today’s ultra-low rates.

Plan ahead to make mortgage qualifying easier

If you’re self-employed and want to buy a home, it helps to plan in advance. Work with a mortgage professional and involve your accountant as well.

You can change the way you write off your business expenses, and the amount of taxable income you show. Alternatively, you can amend previous tax returns to show higher income from the past.

Note that some deductions won’t hurt you. Underwriters add them back into your taxable income:

• Depreciation
• Miles
• Business use of home
• Depletion

Deductions like meals are subtracted from your income.

You and your accountant can check out the form underwriters use and see how lenders will view your income right now.

Self-employed mortgage rates

Buying a home or refinancing when you’re self-employed might not be as difficult as you think.

Self-employed borrowers have access to the same mortgage programs and the same low rates as other borrowers in today’s market.

It’s up to you to shop around for the best loan program and lender for your needs.

Comparing at least 3 mortgage offers will help you find the lowest interest rate and best terms possible.