How to Calculate Self-Employed Income for Mortgage Loans

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Mike Romano

Jul 11, 2023

Mike Romano is a mortgage industry veteran with over 20 years of experience. His expertise spans mortgage technology, credit risk, and loan origination, and he has spoken at many mortgage and fintech conferences. He has a Bachelor's and MBA from the University of California, Berkeley and currently resides in Austin, TX. NMLS # 2515901

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    If you’ve been self-employed for any length of time, you probably already know that showing proof of your income can be a pain, to say the least. 

    Although self-employment has become more common in the last few years, it’s still considered to be unconventional by many institutions. For example, any institution that plans to give you money. Namely, mortgage lenders. 

    Of course, that doesn’t mean you can’t get a mortgage loan as a self-employed person. People do it every day. It just means lenders need a bit more information before they make a decision. 

    We’ll show you how to calculate self-employed income for mortgage loans and what documents you need to gather so mortgage lenders can verify that income.

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      Disclaimer: This article is for informational purposes only and should not be considered as legal or financial advice. Please consult an attorney, mortgage lender, or CPA for guidance on your specific situation.

      How to calculate self-employed income for mortgage loans

      At a high level, when you think about how to calculate self-employed income for a mortgage loan, remember lenders need to know two things:

      • Do you make enough to afford your mortgage payments right now?
      • Is your self-employed income stable enough to make your payments into the future?

      That’s why banks need a bit more information from self-employed applicants than they do from those with W-2 employment. Lenders typically want to see your average self-employed income over the last two years. This gives them a picture of how much money you make, as well as the stability of your income. 

      Your mortgage lender will do their own calculations to determine your self-employed income, and these calculations are a bit complex (we’ll explain more in a minute). But it’s still a good idea to do some rough math yourself, before you approach a lender. 

      Just be aware that your numbers will likely differ somewhat from those of your mortgage lender. 

      Making a rough calculation before you approach a lender

      If you are self-employed, most lenders use a combination of your Adjusted Gross Income (AGI) and your profit-and-loss statements. 

      From there, the lender usually adds back in certain business deductions, such as equipment depreciation, which effectively increases the amount of business income you can count. Some underwriters also have the discretion to disqualify certain extraordinary business expenses, like one-time late fees. 

      As we said, all of this gets complicated. If you have a complex business structure with a lot of depreciation, you may want to consult your CPA for help calculating your self-employment income. 

      But for the purposes of doing your own rough calculations, you can simply use your Adjusted Gross Income (AGI). 

      Here’s how to calculate your self-employed income for mortgage loans: 

      • Find your Adjusted Gross Income (AGI) for the past two years. (For tax year 2022, this is line 11 of the 1040 form.) 
      • Add together your AGI from the past two years. 
      • Divide the total by 24.

      This will show you your average monthly income over a two-year period. 

      For example, if your AGI for the past two years was $78,000 and $86,000 respectively, your calculation looks like this:

      AGI from last two years$78,000 + $86,000 = $164,000
      Average monthly income $164,000 / 24 = $6,833.33

      That means you averaged $6,833.33 per month over the last two years. Lenders look at this average monthly income because self-employed people often have good months and bad months.

      Banks don’t want to give a loan based on a couple of good months or deny a loan because the last few months have been slow. Therefore, averaging your income over a longer period of time gives them a better understanding of whether or not you’re a good mortgage loan candidate.

      Do mortgage lenders look at total income or adjusted gross income for the self-employed? 

      If you have standard W-2 employment, mortgage lenders look at your Total Gross Income (your income before any deductions) to determine how much to lend you. But this isn’t the case if you’re self-employed. 

      As we talked about earlier, if you are self-employed, mortgage lenders look at the Adjusted Gross Income (AGI) listed on your federal tax returns. Your AGI is your income minus certain deductions, such as a portion of your self-employment tax or your self-employed health insurance deduction. 

      Herein lies the catch 22 for a self-employed individual looking to qualify for a mortgage loan. 

      When you file your taxes each year, these deductions are a blessing. They lower your taxable income, which in turn reduces the amount of taxes you owe. Unfortunately, when you go to apply for a mortgage loan, these deductions also lower the income that can be counted toward your eligibility. 

      It’s frustrating. But it is a frustration you need to take into account when you calculate your self-employed income for a mortgage loan. 

      Learn more: What is the income required for a 400K mortgage? 

      How do I show proof of income for a mortgage if I’m self employed?

      Self-employed individuals essentially prove their income the same as people with W-2 employment: using tax documents. Being self-employed just means you have more tax documents to show.

      Lenders may or may not not ask for all of the documents on this list, but it’s wise to gather as many as you can ahead of time.

      Bank statements

      You’ll typically need to dig up bank statements from the previous 12 to 24 months. Lenders will cross reference your bank statements with your other documents.

      W-2

      If you pay yourself a paycheck as an owner-employee, you’ll also cut yourself a W-2 at tax time. Your lender will ask for this as part of your income documentation. 

      Personal tax returns

      Your standard personal tax return is also important. This includes your 1040 as well as any other schedules you are required to file. Gather all of these documents from the past two years of tax filings. 

      If you have a W-2 as an owner-employee, your tax return verifies everything on the W-2 is correct. It also shows any additional income, such as business profits not listed on your W-2. 

      1099 forms 

      1099 forms are yet another form of income verification. You’ll definitely need your 1099 forms if you don’t have a W-2, and lenders might ask for 1099 forms even if you have a W-2. 

      Business tax forms

      K1s, as well as forms 1120 and 1120S, help verify your business’s income. This shows lenders that the source of your personal income is stable.

      Profit and loss statements 

      Most lenders want to see profit and loss statements for the last two years. They compare the numbers to your tax records to make sure nothing seems fishy. They also look for major fluctuations in revenue.

      Current client list

      This shows you still have the business to support the income that’s shown on your other documents. Depending on the nature of your business, this may or may not apply to you. 

      CPA endorsement 

      Lenders use this to help verify that you’re still operating your business.

      Explanation letter

      Sometimes lenders will need you to explain unusual situations, such as a big change in revenue from one year to the next or why most of your revenue is generated during a certain time of year.

      As you can see, this list of documents is longer than the documentation required for a traditional W-2 employee. It will save you a lot of headache if you have all of them on-hand in advance. It eliminates a lot of inconvenient back and forth between you and the lender if you give them a complete package right from the start.

      Can I get down payment assistance if I’m self employed?

      Yes, down payment assistance (DPA) is available for self-employed homebuyers. Typically, DPA programs look at your personal income and your credit score to determine eligibility. If the program asks for income verification, your personal tax returns are usually sufficient.

      Some down payment assistance programs come in the form of loans, such as DPA loans and deferred repayment loans. These programs may require you to provide personal tax documents. However, it’s normal for DPA loans to be approved contingent on approval from the lender.

      This just means that you’ll get a tentative approval from the down payment assistance program, but they won’t finalize the down payment loan or dispense any funds until you get loan approval or pre-approval from the mortgage lender. 

      In this case, the down payment assistance program may end up simply trusting the lender’s financial assessment, rather than doing their own.

      Learn more: 

      Can I qualify for a mortgage loan based on income from new self-employment?

      It’s possible, but it can be quite challenging. The general rule about qualifying for mortgage loans based on income from self-employment is that you should have two years of tax documents that show steady self-employment income.

      If you’re applying for a mortgage loan on self-employed income that is less than two years old, be prepared to provide all of the documents listed above and potentially show some cash reserves that you can use to pay expenses if you lose your income.

      Since you don’t have as much documentation to prove the stability of your income, it’s also possible that you may have to pay a higher interest rate on your mortgage. Additionally, some lenders simply won’t give you a mortgage loan until you’ve been successfully self-employed for at least two years, so you may have to shop around for a lender.

      Again, it’s not impossible to get a loan with less than two years as a self-employed worker, but it’s challenging. Be prepared for a rigorous loan approval process if you’re newly self-employed.

      What types of self-employment income do mortgage lenders consider?

      Broadly, lenders are looking for steady, recurring income. This means they prefer income which is continuing, not a one-off payment. It’s okay if your business runs by moving from contract to contract, since your documentation from the previous years will show that these individual contracts are not one-time anomalies.

      This is what lenders consider to be self-employed income for the purposes of mortgage loan qualification:

      • Fees earned from freelance, contract, or gig work
      • Consulting fees
      • Income from seasonal work
      • Business revenue and any salary you earn from your business
      • Income from rental properties
      • Investment income

      Retirement income and spousal or survivor’s benefits can also count as part of your gross income. However, you’ll need documentation to show that you’re eligible to receive payments from these sources for at least the next three years. 

      Here’s an easy way to think about what types of self-employment income mortgage lenders will consider: if you can claim it on your taxes, lenders will most likely consider it as income.

      Stretching your income further with down payment assistance

      Regardless of how much you make from self employment, or where that self-employment income comes from, making a larger down payment is the best way to top-off your home buying power.

      Down payment assistance (DPA) helps you make the largest down payment possible, which in turn lowers your monthly mortgage payments or allows you to purchase a more expensive home. Unfortunately, it’s tough to find information about DPA programs. 

      Stairs Financial gives you all the information you need, all in one place, and curated based on your individual circumstances.

      Stairs matches your information with a huge database of loan options offered by trusted lenders. You get a targeted list of loans and any down payment assistance programs for which you qualify, making it easy to compare your options side-by-side, apples-to-apples.

      You also get access to knowledgeable lenders who understand the nuances of your specific down payment assistance program, so you can reduce the headaches of buying a home and ultimately get the most benefits possible.

      Learn more.

      Find up to $15,000 towards a home 🏠

      Compare local down payment assistance and find a mortgage, fast.

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