Qualifying for a Mortgage with Self Employed Income – 2017 UPDATE
Self Employed Easier?
On May 30th, 2017 Fannie Mae announced a shocking relaxation of the guidelines that determine how self employed borrowers calculate their qualifying income when applying for a home loan.
Freddie Mac announced changes to their self employment income guidelines earlier this year.
The Fannie Mae update now offers more options to self employed borrowers.
The new Fannie Mae guidelines go into affect after the weekend of July 29th, 2017, when the DU (desktop underwriter) automated underwriting system will be updated to version 10.1
This is a major update that represents a significant move toward relaxing the guidelines for home owners and home buyers wanting to use Conventional financing.
The major event that we are going to talk about here is how Fannie Mae looks at self employed income calculations.
Calculating Self Employed Income
Calculating self employed income has always required average the 2 most recent years Net taxable income from your Federal tax returns.
The averaging of Net taxable income becomes a deal killer if:
- Your previous year income was very low
- Your previous year income was higher than your most recent year
If your previous year’s income was very low, averaging it with your current year can still result in an average monthly income that doesn’t quite get you to where you need to be.
If your previous year’s income is higher than your most recent year, then you have a situation where “on paper”, your income appears to be declining.
I’ve seen scenarios where your income does not decline, but your expenses increase, which causes a declining income situation. In these cases, the underwriter may choose to use the lower of the 2 years to determine your qualifying income, and not the higher income of the previous year.
Fannie Mae DU 10.1 Update (after July 29th, 2017)
With DU version 10.1, conventional loans are now more likely to require only one year tax returns when qualifying for a home loan.
Under the new Fannie Mae guideline, the criteria that determines the documentation required to verify a self-employed borrower’s income will be updated.
The number of loans that are eligible for the one year of personal and business tax return documentation requirement will increase.
This is not uncommon for Fannie Mae to make updates that considers compensating factors to offer exceptions to the published guidelines.
This feels a little bit like a toe in the water by Fannie, but it’s a big toe, and a great start toward loosening the documentation requirements for self employed income borrowers.
Freddie Mac Self Employed Income
Freddie Mac has always been more flexible than Fannie Mae when allowing for only 1 year tax returns for self employed income borrowers with compensating factors.
The number of years of required tax returns will be based on the number of years the business has been in existence
- For businesses operating for five or more years, one year of business and personal returns will be required
- For businesses operating for less than five years, two years of business and personal returns will be required
This guidelines simplifies the “compensating factor” question to time in business.
FHA Self Employed Income Guidelines
Minimum Length of Self-Employment
An underwriter will consider Self-Employment Income if you have been self-employed for at least two years.
If you have been self-employed between one and two years, the underwriter may only consider the income as qualifying income if you were previously employed in the same line of work in which you are now self employed, or in a related occupation for at least two years.
Stability of Self-Employment Income
Income obtained from businesses with annual earnings that are stable or increasing is acceptable. If the income from businesses shows a greater than 20 percent decline in qualifying income, the loan must downgraded and manually underwritten.
Complete individual federal income tax returns for the most recent two years, including all schedules.
Alternative Income Options
Do not assume that all lenders understand how to calculate self employed income properly. Even if you show little to no income on your personal tax returns, there may be an opportunity to adjust those numbers to show more qualifying income.
Depletion and depreciation claimed on a Schedule C or business tax return can be added back into your qualifying income calculation. In some cases, you can also add back in any deductions for mileage that you take on your tax returns.
Bank Statement Programs
There are portfolio programs available for self employed income borrowers that cannot show enough income on your tax returns.
These loans tend to require a higher downpayment, higher rates and higher closing costs.
It is common for these programs to allow you to use a percentage of your personal or business bank deposits. The deposits are scrutinized to make sure they are consistent with the amount and frequency of business related activities.
Bank statement deposits will be averaged over 12 or 24 months, depending on what investor you are using.
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