How to Calculate Self Employed Income for Mortgage Loans
Being self-employed can offer many benefits, such as flexibility and independence. However, when it comes to obtaining a mortgage loan, it can sometimes be challenging to calculate your income. Unlike salaried individuals who have a consistent paycheck, self-employed individuals have fluctuating incomes, making it difficult for lenders to assess their ability to repay a loan. However, by understanding how to calculate your self-employed income, you can increase your chances of qualifying for a mortgage loan. In this article, we will explore the steps to calculate self-employed income for mortgage loans and answer some common questions.
1. Gather your financial documents: Start by collecting all the necessary financial documents, such as your tax returns, bank statements, profit and loss statements, and any other relevant documents that show your income and expenses.
2. Determine your average monthly income: Look at your tax returns from the past two years and calculate your average monthly income. Add up your total income for those years and divide it by 24 (months) to get your average monthly income.
3. Include all sources of income: Include all sources of income in your calculations, such as income from your business, rental properties, investments, or any other sources.
4. Consider non-taxable income: Some self-employed individuals may receive non-taxable income, such as disability or social security benefits. Include these amounts in your calculations as they contribute to your overall income.
5. Deduct business expenses: Deduct your legitimate business expenses from your total income to arrive at your net income. Make sure to only deduct expenses that are necessary and directly related to your business.
6. Review your profit and loss statements: Profit and loss statements provide a clear picture of your business’s financial health. Lenders may require these statements to assess your income. Make sure your profit and loss statements are accurate and up to date.
7. Consider your debt-to-income ratio: Lenders look at your debt-to-income ratio to determine your ability to take on additional debt. Calculate your debt-to-income ratio by dividing your total monthly debt payments by your gross monthly income. Aim for a debt-to-income ratio below 43% to increase your chances of loan approval.
8. Prepare a year-to-date profit and loss statement: To provide a more accurate representation of your current income, prepare a year-to-date profit and loss statement. This statement should include your income and expenses up to the current month.
9. Seek professional assistance: If you find the process of calculating your self-employed income overwhelming, consider seeking assistance from a certified public accountant (CPA) or a mortgage professional who specializes in self-employed individuals. They can guide you through the process and help you present your income in the best possible light to lenders.
10. Have a solid credit history: Along with your income, lenders also assess your credit history. Maintain a good credit history by paying your bills on time, keeping your credit utilization low, and avoiding new credit applications before applying for a mortgage loan.
11. Keep detailed records: It is crucial to keep detailed records of your income and expenses. This includes receipts, invoices, bank statements, and any other financial documents that support your income claims.
12. Be prepared for additional scrutiny: Self-employed individuals often face more rigorous scrutiny when applying for a mortgage loan. Be prepared to provide additional documentation and explanations to lenders to demonstrate your ability to repay the loan.
Frequently Asked Questions (FAQs):
Q1. Can I get a mortgage loan if I have been self-employed for less than two years?
A1. Yes, it is possible to get a mortgage loan if you have been self-employed for less than two years. However, you may be required to provide additional documentation and have a stronger credit history to compensate for the shorter self-employment period.
Q2. How do lenders verify my self-employed income?
A2. Lenders typically verify self-employed income by reviewing tax returns, profit and loss statements, bank statements, and other financial documents. They may also contact your CPA or tax preparer to verify the accuracy of your income claims.
Q3. Can I use my business’s gross income instead of net income to qualify for a mortgage loan?
A3. In most cases, lenders require the use of your net income (income after deducting business expenses) to assess your ability to repay a mortgage loan. However, some lenders may consider using your gross income if you can provide a valid reason and supporting documentation.
Q4. How can I improve my chances of getting approved for a mortgage loan as a self-employed individual?
A4. To improve your chances of getting approved for a mortgage loan, maintain good credit, keep detailed records of your income and expenses, have a solid down payment, and work with a mortgage professional who specializes in self-employed individuals.
Q5. Do I need to provide tax returns for the past two years?
A5. Providing tax returns for the past two years is a common requirement for self-employed individuals. However, some lenders may accept tax returns for one year if you can provide a valid reason, such as a significant increase in income during that year.
Q6. Can I use projected income to qualify for a mortgage loan?
A6. In general, lenders prefer to use historical income (average monthly income from the past two years) to assess your ability to repay a mortgage loan. However, some lenders may consider using projected income if you can provide a solid business plan and supporting documentation.
Q7. What if my income fluctuates significantly from year to year?
A7. If your income fluctuates significantly from year to year, lenders may average your income from the past two years or require additional documentation to explain the fluctuation.
Q8. Are there specific mortgage programs for self-employed individuals?
A8. Yes, there are specific mortgage programs designed for self-employed individuals, such as bank statement loans or stated income loans. These programs may have different requirements and eligibility criteria.
Q9. Can I include my spouse’s income if they are not self-employed?
A9. Yes, you can include your spouse’s income if they are not self-employed. However, their income will be assessed separately, and lenders may require additional documentation to verify their income.
Q10. Can I use a co-signer to qualify for a mortgage loan?
A10. Yes, you can use a co-signer to qualify for a mortgage loan. The co-signer’s income and credit history will be taken into account during the loan approval process.
Q11. What if my self-employed income is irregular or seasonal?
A11. If your self-employed income is irregular or seasonal, lenders may use an average of your income over a longer period, such as three years, to assess your ability to repay a mortgage loan.
Q12. Can I apply for a mortgage loan if my business is relatively new and has not yet turned a profit?
A12. It can be challenging to qualify for a mortgage loan if your business is relatively new and has not yet turned a profit. Lenders typically prefer to see a stable and profitable business history. However, some lenders may consider other factors, such as your credit history and financial stability, to make a lending decision.
In conclusion, calculating self-employed income for mortgage loans requires careful consideration of various factors. By gathering the necessary financial documents, keeping detailed records, and seeking professional assistance if needed, you can present your income in the best possible light to lenders. Remember to maintain a good credit history and be prepared for additional scrutiny during the loan application process.