Get Mortgage-Approved With Just One Year Of Tax Returns
Self-employment is both exciting and challenging.
You make your own hours and you have the potential to increase your income. There’s satisfaction in building your own company rather than someone else’s.
One of the potential challenges of being self-employed, though, is getting a mortgage.
For one, tax write-offs reduce the amount of income that the mortgage underwriter can consider.
And, self-employed mortgage applicants must prove stability of employment and income, usually going back two years. This is a bit tougher than it is for regular salaried employees.
Fortunately, there is a way to use just one year of tax returns to qualify for a mortgage. This can help newer business owners, as well as those who experienced a down year in the past.
Whether you are looking to buy a home or refinance one, you may be able to qualify by showing only your most recent year of income.
Getting Approved As A Self-Employed Applicant
A self-employed borrower is any individual who has 25% or greater ownership interest in a business.
According to conventional mortgage guidelines published by Fannie Mae, underwriters consider the following factors to approve a self-employed borrower.
- The stability of the borrower’s income
- The location and nature of the borrower’s business
- The demand for the product or service
- The financial strength of the business
- The future outlook of the business
Two points stand out here when getting approved as a business owner: stability and consistency.
The way underwriters measure stability is by looking at length of history in that business specifically, and in that field.
They typically want to see a two-year history in the respective industry. This is where you may be granted an exception if you haven’t been self-employed the whole two years in that line of work.
To see who might qualify for a loan with only one year of self-employment, we will look at two situations and how an underwriter would handle them.
Case Study: Different Amounts Of Self-Employment History Needed
The following two scenarios describe applicants for whom the mortgage underwriter would likely make a different approval decision. Due to previous lines of work, one would need two years’ experience running their own business, the other might only need one.
Case study 1: a self-employed applicant needing two years’ experience
This applicant is looking to buy a home and has been self-employed as an insurance broker for one year. He has done well and has made over $100,000 in his first year in the business.
Prior to getting into the insurance sales business he was a successful grocery store general manager. In his previous role he made $90,000 annually for many years.
However, the underwriter is unable to approve the mortgage because the two industries are not related. A grocery management role is not similar enough to that of an insurance broker.
The applicant is off to a good start, but his income is still viewed as “unstable.”
In this case, the borrower will need a 2-year history of self-employment in the insurance business before he will be eligible for a traditional mortgage.
Case study 2: a self-employed applicant with one year in the business
A borrower is looking to buy a home and has owned her web design business for 14 months. She has a full-year tax return that demonstrated that she made $80,000 in net profit in her first year in the business.
Prior to going off on her own, she worked for a large online marketing firm as a web development team leader for several years and climbed the corporate ladder.
She averaged $70,000 year for the last two years before she left the company, and decided to go off on her own.
This type of scenario demonstrates stability and would likely be approved assuming the applicant supplied the right documentation, such as a tax return and year-to-date profit and loss statement.
Ask The Lender To Use Different Approval Software
In some cases, the underwriter won’t ask you to provide a full two years’ worth of tax returns.
Most applicants’ files are run through computerized underwriting systems, then verified by real person. The underwriting software, in some cases, will ask for the most recent year of tax returns only.
The one-year requirement typically comes from “Loan Prospector,” which is Freddie Mac’s loan approval software. Fannie Mae’s version of the software is less likely to give you a one-year requirement. Most lenders can approve loans via Freddie Mac or Fannie Mae.
If you have been self-employed less than two years, ask your lender to try running your scenario through Loan Prospector. There’s a chance this system will require you to document less self-employment than would another system.
If you receive the reduced, one-year requirement, it’s important to understand that your tax return must reflect a full year of self-employment income.
For example, if you became self-employed in April 2015, that year’s tax returns are not going to reflect a full year.
If you started your business in November 2014, then your 2015 tax returns will demonstrate a full year of experience running your business.
Showing Your Best Year To Mortgage Underwriters
Freddie Mac’s “Loan Prospector” helps those who only have one year of self-employment under their belt, but also those who had a down year in the past.
By using one year of tax returns, the underwriter doesn’t have to average self-employed income over a two year period.
For example, your business had a one-off, slow year in 2014 where the net income was $50,000. Perhaps you took some time off, experienced a change in the industry, or moved your business to another state.
The next year, you bounced back, and the net income was $80,000.
If the lender were to require two years of tax returns, your income would average out to about $5,400 per month.
But if just one year of tax returns were required, you would use the most recent tax return. This assumes the year-to-date profit and loss statement demonstrates continued profitability. The qualifying income jumps to $6,600 per month based on the most recent year.
The higher income allows you to buy more home, or better qualify for a standard or cash-out refinance.
Overcoming Self-Employed Mortgage Challenges
Buying a home while self-employed can be more challenging than it is for the average salaried employee. But if you know how underwriters look at self-employed applications, you can set yourself up for success.
If you are turned down for your mortgage, don’t give up. There could be a simple solution that your lender has overlooked. Apply again with a different lender, asking about the options presented here.
You might be surprised at how quickly another lender can approve your loan when another could not.
What Are Today’s Rates?
Mortgage rates are low, and it’s an ideal time to apply for a loan, even if you have been turned down in the past.
Lower rates mean that your payments will be lower, and it will be easier to qualify. Get a quote now, and see how low your rate and payment can be. Quotes take just minutes, and no social security number is required to start.