Federal mortgage guidelines require lenders to document and establish a two-year history of a borrower’s prior earnings before approving a conventional loan. This requirement is crucial for the self-employed, as the records determine what kind of mortgages or leases you can get based on this timeline.

Who the lender considers self-employed

The federal mortgage guidelines treat anyone holding a 25% or greater ownership stake in a business as being self-employed, at least for the purposes of a mortgage. The classification decides which documents a mortgage underwriter will request, and how long the review takes. Here’s how it works in some example scenarios.

  1. Sole proprietors who file a Schedule C fall into this category, which covers most freelancers and independent consultants.
  2. Partners in a firm are included, and their K-1 income is analyzed alongside the partnership’s returns.
  3. Owners of an S corporation are still counted within this category, despite the fact that they pay themselves a salary from the business.
  4. Anyone paid mainly through 1099s belongs to this group, even when part of their earnings arrives on a W-2.

The core document set

The foundation of your self-employed financial file is your tax return. Lenders typically want to see a minimum of two years of personal returns, plus two years of business returns if you’re self-employed working for a business that files separate tax returns. In some cases a single year is enough, but only under specific circumstances. 

Every business the applicant is self-employed through has to have been operating for at least five years, and the applicant has to have held a 25% or larger stake in those businesses for all five of those years. If you don’t fulfil both of these requirements, you’ll need to supply the full two years of returns.

Beyond tax returns, underwriters expect to see the following:

  1. Profit and loss statements showing how the business has performed since the last filed tax return.
  2. Twelve to twenty-four months of bank statements confirming that the deposits that have actually been made line up with your other documentation.
  3. A balance sheet that makes it clear what the business owns and what it owes.
  4. A business license or professional registration that proves the business exists as a legal entity.

The Consumer Financial Protection Bureau advises getting these materials togetherwhile you’re still shopping for a loan, before you’ve committed to a specific lender. A complete file allows you to easily shop around for competing offers in the same week.

Producing proof of income

Independent professionals who pay themselves a salary through their own company often have no record of these payments. Taking a reasonable salary from an S corporation makes you a legal employee of that company, and that requires proper wage records for payroll tax compliance and so that any lender or landlord can easily verify recent earnings. Using something like a paystub generator, you can easily format appropriate records for presenting to underwriters.

It goes without saying that accuracy is important, because lenders verify reported income against tax transcripts provided directly from the IRS. Any contradictions between your paystubs and the IRS documentation will immediately halt the application, and you’ll be under pressure to explain the difference. Make sure your paystubs are accurate and correct.

The deduction problem

Qualifying income is based on the net figure on your tax return after every single deduction has been applied. A consultant who bills $400,000 and writes off $180,000 in expenses will be assessed on $220,000, and that’s a much smaller mortgage than gross billing suggests.

If you’re self-employed and make significant deductions, it makes sense to work with an accountant two years before you plan to purchase to make sure you’re structuring your company finances appropriately to get a mortgage.

Lease applications move faster

The evidence required to secure a rental is less stringent than that required for a mortgage. In places like New York, where landlord requirements are quite strict, there’s an annual income requirement of roughly 40 times the monthly rent, and this needs to be verified through the following evidence:

  1. A tax return.
  2. Several months of bank statements.
  3. A credit report.
  4. A letter from an accountant.

In competitive markets, landlords will often ask for someone to be named as a guarantor if self-employed income isn’t up to standards. While the guarantor requirement isn’t a straight-up rejection, it can be challenging to deal with bringing a third party into a significant financial arrangement.

Preparing before you apply

Before you apply get your paperwork organized Lenders and landlords usually request the same financial records tax returns and proof of income so gathering everything ahead of time makes the application process quicker and helps avoid delays

For more guidance on building and managing an independent practice explore our latest articles