How Do Mortgage Lenders Verify Self-Employment Income?

If you’re considering a mortgage but can’t back up your payability with pay stubs or regular reports from a job, you should prepare a little more. 

In particular, if you’re self-employed, you can easily expect your lender to request additional documents and summaries, take extra time to review your funds and expenses, and change the underwriting framework based on your situation. 

However, it will be much easier to prepare for possible extra verification if you learn how lenders work with self-employment income. Let’s take a look at the entire process and its most common stages to help you clarify that. 

How Lenders Work With Self-Employment Income

There are different providers with different approaches, but most commonly, a lender firm conducts a set of complementary checks in order to verify income from self-employment. The exact set can also be adapted to loan program requirements, structure of your business, and complexity of your finances. 

But if we sum up the process, it usually follows these steps:

Checking Whether You’re Really Self-Employed

To start qualifying your case for a home loan, the lender must first understand how exactly you’re earning income and whether your business ownership makes you formally self-employed.

For this, the lender will usually put you under one of the following categories of self-employment:

• Sole proprietors and independent contractors
• Freelancers and consultants
• Small business owners
• Partners in a partnership or members of certain LLCs
• Owners of S corporations or other structures generating business income

You can be formally categorized as self-employed if you own 25% or more of a business interest (based on Fannie Mae’s guidelines for conventional mortgages). But this can vary depending on a loan program and other arrangements. 

A lot depends, also, on whether your income comes from business profits, owner distributions, or a combination of salary and self-employment earnings. Each source may call for a different set of documentation and analyses. 

Reviewing Personal and Business Tax Records

Mortgage underwriting specialists go deeper into your payability record by analyzing your tax returns. In particular, you will need to provide two years of signed federal income tax returns (including related schedules). 

Depending on your business structure and the loan program, they may also require separate business tax returns. But the most relevant documents usually include:

• Form 1040 and Schedule C - reports income or loss of a sole proprietor;
• Schedule K-1 - shows your share of income, deductions, and other items from a partnership or S corporation;
• Form 1065 - reports partnership income and expenses;
• Form 1120-S - reports S corporation income and expenses;
• Form 1120 - reports C corporation income and expenses;
• Schedule E - shows certain pass-through business income and rental income (which you reported on the personal return).

You don’t need to have every form ready — follow the lead of your mortgage consultant or lender to know what selection will be required for your case. 

Cross-Checking Tax Info With IRS

The tax returns that you submit yourself may not be sufficient for some lenders to qualify you. They may additionally request official tax transcripts from the IRS and verify that the info you reported matches the tax authority’s filed records. 

Namely, and only with your personal authorization, a lender can request tax records through the IRS Income Verification Express Service (IVES), commonly using IRS Form 4506-C. The particular transcripts they will be checking depend on the case, of course. 

This stage ends as soon as the lender approves, with no discrepancies between submitted documents and filed tax data. If a return is missing, incomplete, or inconsistent with the available records, be prepared to provide extra documentation. 

Calculating Qualifying Income

By verifying your tax returns, the lender gets a good outlook of your income sources and factors. With this information, the underwriter can start calculating your income to see whether it can be used for mortgage qualification. 

To do that, underwriting specialists may need to examine:

• Net business income, or what you earn after business expenses (not total sales or client payments).
• Income trends, or the stability, increase, or decline of your earnings (over the reviewed period).
• Eligible adjustments, or the adjustment of certain noncash expenses (or other items required by the underwriting guidelines).
• Ownership share, or how much of a partnership or company’s income belongs to you.
• Availability of business earnings, or whether your reported profits can support personal mortgage payments (without undermining your business).

To define your qualifying income, the lender will be focusing on your income stability, business viability, earnings trends, and your ability to receive sufficient income from your business long-term. 

Reviewing Existing Business Finances

Tax returns show how a business performed in previous periods, but they may not reflect your current financial condition. You could have easily reported strong profits last year. But then you lost a huge client just recently, took on a big debt, or went through a decline in demand. 

This is why underwriting specialists must assess your business’s current position, for which they may request additional reports, including:

• Year-to-date profit and loss statements
• Business balance sheets
• Recent business bank statements
• Existing contracts, invoices, or other proof of ongoing work
• Business registration documents or licenses

Checking Your Business Cash Flow and Access to Income

Another common occurrence is when your business is profitable on paper, but it doesn’t really provide enough readily available cash to support your mortgage (or other personal expenses). For instance, an owner of an S corporation or partnership may not actually get the profits that are reported for tax purposes. 

This is why lender companies must look beyond your profit figure to understand:

• Does your business have enough cash to cover payroll, suppliers, debt payments, and other operating expenses while offering qualifying income for a mortgage?
• Is your business liquid enough and able to keep generating earnings after the down payment, closing costs, or reserves?
• What portion of your earnings can be used to support the mortgage (reasonably)?

Additional questions may apply. 

Confirming the Income’s Continuous Flow

Once the lender gets the picture of your past (historical) and present payability, they will also need to verify that your income can continue for as long as the mortgage obligations require (and support other running expenses meanwhile). 

For this, the lender’s specialists may need to additionally read into your business’s:

• recent earning patterns
• surrounding industry conditions
• financial strength
• customer concentration

How LBC Mortgage Can Help You

Need assistance preparing for a mortgage? Turn to LBC Mortgage for full consultation, analysis of your borrower’s position, and automation of mortgage management. 

Author:

Alex Shekhtman CEO & Founder, LBC Mortgage