Buying a Home When You're Self-Employed

Fannie Mae’s Selling Guide describes how a lender verifies the income of a self-employed borrower, through signed federal tax returns or IRS transcripts, and what the lender has to analyze before approving the loan. These are Fannie Mae’s rules for the loans it buys, and your lender can tell you what its own file needs.

Who counts as self-employed

The Selling Guide says any individual who has a 25% or greater ownership interest in a business is considered to be self-employed.

The two-year history

Fannie Mae generally requires lenders to obtain a two-year history of the borrower’s prior earnings, as a way of showing the income is likely to continue. To verify it, the lender may obtain signed federal income tax returns for the past two years, individual returns and in some cases business returns, with all applicable schedules attached. Alternatively it may use IRS-issued transcripts of the individual and business returns for the most recent two years, as long as the information is complete and legible and includes all the applicable schedules.

Under two years

The income of a person with less than a two-year history of self-employment may be considered if the borrower’s most recent signed personal and business federal returns reflect a full 12 months of self-employment income from the current business. The loan file must also document prior income at the same or a greater level, in a field that provides the same products or services as the current business or in an occupation with similar responsibilities. In those cases the lender has to give careful consideration to the borrower’s level of experience and to the amount of debt the business has taken on.

One year of returns

The lender may work from one year of personal and business returns if the business has been in existence for five years and the borrower has held an ownership share of 25% or more for the past five years consecutively. The lender also has to complete a cash flow analysis and keep a copy in the loan file. Each business is assessed separately against the five-year benchmark, so the number of years of returns can differ when there’s more than one source of self-employment income.

When business returns can be waived

With two years of signed individual returns, the lender may waive the requirement for business returns if the borrower is using personal funds for the down payment, closing costs and reserves. Two more conditions apply: the borrower has been self-employed in the same business for at least five years, meeting the five-year and 25% ownership requirements described above, and the individual returns show an increase in self-employment income over the past two years from that business.

How a Schedule C is read

For a sole proprietorship, the income or loss is calculated on Schedule C. The lender may need to adjust the net profit or loss shown there to arrive at the borrower’s cash flow. Recurring items claimed on the schedule, namely depreciation, depletion, business use of a home, amortization and casualty losses, must be added back. Non-recurring income must be deducted in the cash flow analysis, including any exclusion for meals and entertainment expenses reported by the borrower on Schedule C.

What else the lender looks at

Before approving the loan, the lender has to analyze the stability of the borrower’s income, the location and nature of the business, the demand for its product or service, the financial strength of the business, and its ability to keep generating and distributing enough income to make the loan payments. The Selling Guide also notes that business income from a partnership or S corporation reported on a personal return may not be income actually distributed to the borrower.

Getting ready

Find out which years of returns your lender wants and whether it’ll accept transcripts. Self-employed and thinking of buying? Ask me where to start. Diana Kim, REALTOR®, eXp Realty.