There are plenty of self-employed borrowers who need to borrow money to buy homes. And while the requirements are slightly different than those of W2 employees, loans are being made. Basically the guidelines that Freddie Mac and Fannie Mae mandate for the self-employed borrower are stricter than for the borrower who is an employee. For example, the income that the mortgage industry allows for a self-employed borrower is based on income that has been reported to the IRS and may even be averaged over a two year period; however, the wage earner who receives a raise gets to use that new income immediately to qualify for a mortgage.
For sole proprietors, the income that is used to qualify the borrower must come from the bottom line on Schedule C of the federal tax returns. It is called “Net Profit” and is divided by 12 to come up with the monthly qualifying income. The net profit is what is left after the tax payer deducts all of his expenses from his gross income. The more deductions the taxpayer claims, the lower the net profit and the lower the income tax liability; however, it also reduces the purchasing power of the borrower. Underwriters will typically ask for two years of federal tax returns plus a year-to-date profit and loss statement for the current year. Borrowers who own 25 percent or more of a partnership, LLC or corporation must also provide the partnership returns and/or corporate returns for one to two years.
Depending on the circumstances, an underwriter may not allow cash that sits in a business account of a self-employed borrower to be used towards the down payment or closing costs for a home purchase since the business may be hurt by a depletion of business funds. A CPA letter may be required that states the business will not be hurt by removing funds from a business account.
There may be other requirements, but the point of this reminder is that self-employed borrowers are not being excluded from the American Dream of home ownership – just that there may be a few additional underwriting steps.
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