How To Calculate Self-Employed Income For Mortgage Loans

When you submit an application for a mortgage, your lender will examine your income to determine whether you can afford the loan. It’s almost simple for those who are employed because you can use recent tax returns, pay stubs, and W-2s. But what happens if you’re self-employed?.

You may be wondering how to determine your income for a mortgage if you’re a small business owner, gig worker, freelancer, or independent contractor. Learn how to estimate your self-employment income in this article to decide whether you should buy a house outright or refinance one.

Who is Considered Self-Employed Individuals?

Anyone who works for themselves rather than a business is considered self-employed, and they typically report self-employment income. However, you must demonstrate that you have worked for yourself for at least two years.

25% or More Ownership in a Business

You are regarded as self-employed if you own at least 25% of a company. However, in order for the company to determine your qualifying income, mortgage lenders will need you to provide additional documentation.

You must disclose your business income on Schedule C of your tax returns if you are a sole proprietor. Additionally, if your business is organized as a corporation, partnership, or S corporation, you must file business tax returns and include information about it on Schedule E of your personal tax returns.

A freelancer is a self-employed individual who makes money by offering services to numerous clients, usually on a temporary basis. Even though they can accept contracts from businesses and organizations, freelancers are still regarded as self-employed.

A contract worker is someone who enters into a legal agreement with a company or business to perform specific services for a set period of time in exchange for payment, also known as an independent contractor or 1099 earner. Though they sign a contract, they remain self-employed individuals.

Seasonal workers, as the name implies, offer their services to satisfy a company’s transient needs at specific times of the year. This includes companies that are open during peak seasons but closed during off-peak periods.

Gig and Side Job Workers

Independent contractors and freelancers who work on transient projects for a variety of clients are known as gig workers. Typically, they enter into formal contracts with high-demand businesses to provide services in exchange for payment.

Self-employed Gross vs. Net Income

Gross income for self-employed people is their total income before taxes and other deductions. This can be your employer’s salary, rental income, dividends, and compensation for services rendered prior to deducting retirement contributions and health insurance premiums.

On the other hand, your net income, also known as take-home pay, is the amount of money you actually keep after taxes and other deductions. While self-employed people receive gross pay and are responsible for paying their own taxes, most W-2 employees receive their net income in a paycheck with taxes already deducted.

What Type of Income Will Mortgage Lenders Consider?

Lenders will require evidence of a steady income when you apply for a mortgage to make sure you can afford your monthly payments without defaulting. Lenders typically consider a variety of income sources, depending on your circumstances, including:

Self-employment Income: This is arguably the most popular type of income that lenders look at when evaluating your eligibility for a loan. You’ll need to provide alternative documentation, such as bank statements, profit and loss financial statements, or liquid assets, as proof of income instead of using pay stubs, tax returns, and W-2s.

Investment Income: If your investments earn you interest and dividends, lenders will want to see that too. You must provide documentation showing you have received interest payments and dividends from your investments over a specific period, typically two years. Lenders will use the information to determine if you qualify for a mortgage loan.

Rental or Property Income: For real estate investors with rental property, lenders will want to see your rental income. You must show proof of rental income in your tax returns.

Spousal or Survivor’s Benefits: Mortgage lenders also consider spousal or survivor’s benefits as sources of income that can help you qualify for a home loan. If you want to use this type of income to secure a mortgage, you must prove that you’ll receive these benefits for the next three years.

Retirement Income: If you’re using your retirement accounts to apply for a mortgage loan, your lender will need to prove that your payments will continue for at least three years from the date of your mortgage. Most lenders use 70% of these accounts to evaluate your eligibility since they can drop in value.

How to Calculate Self-Employed Income

The majority of mortgage lenders prefer to see evidence of your consistent income as well as at least two years of self-employment income.

Follow these easy steps to determine your self-employment income for a mortgage application:

Find your net income from Schedule C on your tax returns for the two most recent years

Add the two figures together

Divide the result by 24

The income needed to qualify for a mortgage, for instance, would be $95,000 + $98,000 = 193,000 divided by 24 if your net income for years one and two was $95,000 and $98,000, respectively. The result is $8,041per month.

It’s important to remember that lenders might be reluctant to loan you money if your income declines year after year because it might be a sign of a failing business.

What Else Can Self-Employed Individuals Show as Proof of Income?

You can additionally demonstrate your income as a self-employed borrower by giving:

Bank Statements: Your bank statements can serve as proof of income when applying for a mortgage. Lenders usually require 12 to 24 months’ worth of bank statements. If you use one account for personal and business banking, you’ll need to highlight all the business-related payments.

Profit and Loss Statements: A profit and loss statement shows all your total revenue, business expenses, and profits over a given period of time. You’ll not only use it as proof of income to qualify for a loan program but also to help make better business decisions.

1099 Forms: This is a tax form given to freelancers and independent contractors. The 1099 form contains the self-employed individuals’ tax identification number or SSN and the amount paid to you by the client, which is why it can serve as proof of income.

Self-Employed Pay Stubs: You can also create pay stubs if you’re self-employed using a stub generator and use them as proof of income. For a self-employed pay stub to be considered legally valid, it must include gross pay, deductions like Medicare, Social Security, state and local taxes, and net pay.

Are There Mortgage Loans Specifically for Self-Employed Individuals?

Yes, there are numerous mortgage options available to borrowers who are self-employed. The most popular loan options include:

Bank Statement Loan: You can get a mortgage using your bank statement rather than tax returns, pay stubs, or W-2s.

Asset Qualifier Home Loan: If you have a lot of assets, you can use them to secure a mortgage loan.

Investor Cash Flow Home Loan: This is ideal for real estate investors as they can use the cash flow from their property to qualify for a mortgage,

Jumbo Loan: A loan product for homeowners looking to purchase property exceeding the conforming limits set by the Federal Housing Agency.

ITIN Mortgage: Individuals without Social Security numbers can use ITIN to qualify for a home loan.

1099 Income Loan: Freelancers and independent contractors can use 1099 forms to pursue their dream of homeownership.

Foreign National Program: Non-citizens can purchase a house or refinance in the U.S. with a foreign national program.

Through Angel Oak Home Loans, you may obtain the aforementioned self-employed mortgage. Simply fill out an online form to request information about the loan product you’re interested in.

FAQ

How do I show self-employed income for a mortgage?

Paystubs and W-2s are acceptable forms of identification for people who are purchasing a home and have regular employment. However, self-employed people’s income records might consist of: Two years’ worth of personal tax returns two years’ worth of business tax returns, including K-1, 1120, and 1120S schedules

Do mortgage lenders look at gross income for self-employed?

Lenders determine your self-employment income based on your net business income rather than your gross sales or revenues before deducting business expenses. This is an inherent problem for self-employed borrowers. Most people want to pay less taxes.

What do mortgage underwriters look for self-employed?

If you want to buy a house but are self-employed, you fill out the same mortgage application as everyone else. When you’re a self-employed borrower, mortgage lenders also take into account the same factors: your credit score, the amount of debt you have, your assets, and your income.