The professional landscape is changing. More and more people are working as independent contractors, freelancers, or vendors either in addition to or in place of traditional employment. While this type of work can be richly rewarding, it can sometimes make it more challenging to find a home loan that works for your needs. Fortunately, many mortgage lenders are adapting to the growing demand by offering mortgage products designed for 1099 earners.
Conventional Mortgages for 1099 Earners
Most traditional mortgage programs require two years of 1099 income and tax returns for self-employed borrowers; however, there may be some instances where a 1099 borrower may be able to get approved with only one year of 1099 income documented. Nevertheless, even with somewhat flexible loan guidelines, 1099 borrowers may find that those flexibilities come at a premium. Higher interest rates help lenders balance the higher risk of loaning money to borrowers with less-predictable income; therefore, conventional mortgages may not always be the best option for 1099 earners.
FHA loans (mortgages backed by the Federal Housing Administration) also allow 1099 income; however, the FHA lender will likely also require two years of 1099 income and tax return documentation. Additionally, FHA lenders may contact your primary 1099 source of employment to verify that you are still a contractor with them and if they plan to retain your services. If you receive 1099 income from multiple sources, the FHA lender may contact your accountant (if you use one) to verify your sources of income. The bottom line is that, in most cases, whether with conventional or government-backed loans, 1099 earners will have to clear a few extra hurdles when it comes to getting a mortgage.
Simple Access™ 1099 Only Mortgage
Luxury Mortgage’s Simple Access™ mortgage products are a collection of home loan options designed to make home financing more accessible for borrowers who may not fit the typical mold. Self-employed borrowers, investors, or those who’ve had recent credit events may not qualify for traditional home loans. With the Simple Access™ home loans from Luxury Mortgage, non-traditional borrowers can have more options at their disposal. The 1099 Only program is a recent addition to our Simple Access™ line of mortgage products.
With Luxury Mortgage’s 1099 Only Program, 1099 borrowers who wish to apply for simple, affordable home financing can choose to exclusively use their 1099 income for their application. No other income verification is required under this program. This makes the application and approval process relatively fast and simple.
There are several beneficial features of the Simple Access™ – 1099 Only Program:
- Loan amounts up to $3M
- Interest-only feature available with 30-year term
- DTI up to 50
- Credit scores as low as 680
- All occupancy types allowed
- 7/1, 10/1 Adjustable Rate Mortgages available
- 15, 30 Fixed Rate Mortgages available
- Multiple financed properties allowed
- Multiple 1099 qualification options
Required Documentation
To qualify for Luxury Mortgage’s 1099 Only Mortgage Program, borrowers will likely need the following documentation:
That’s because calculating self-employed income requires looking through dozens or even hundreds of pages of tax returns, not just two simple pay stubs.
But knowing how to calculate self-employed income for mortgage loans will put you in a better position to provide the necessary documentation, and get approved more easily.
Check your mortgage eligibility.
How to calculate self-employed income for mortgage loans
In calculating your income from self-employment, lenders use your net business income and not your gross sales or revenues before business expense deductions.
This is an inherent problem for self-employed borrowers. Most people want to pay less taxes. So, they maximize write-offs (business expenses). But that means they have lower “on-paper” income with which to qualify for a mortgage.
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If you plan to get a mortgage in the next two or three years, be mindful of how much you write off.
Lenders will add non-cash expenses like depreciation and amortization to your net income. However, they won’t add back deductions taken for cellphones, internet, or business travel.
The lender will also average your self-employment income. For example, if your net self-employment income in 2020 was $50,000, and $70,000 for 2021, they will recognize your income to be $60,000, or $5,000 per month
This is calculated as follows:
$50,000 (2020) + $70,000 (2021) = $120,000 divided by 24 months = $5,000 per month
Get your personalized self-employed income analysis.
Beware of declining income
There can be complications if your income is declining. If your 2020 net income from self-employment was $70,000, and $50,000 for 2021, the lender wouldn’t average your income over 24 months. Instead, they’ll recognize only your 2021 income of $50,000, and average it over just 12 months. That will produce a monthly qualifying income of just $4,166 per month ($50,000 divided by 12).
The lender will use the lower income because your business is showing a pattern of declining earnings.
But that’s the optimistic outcome. A lender may reject your self-employment income entirely if they determine that the declining trend might lead to your business failing.
Extraordinary, one-time events for self-employed borrowers
Fortunately, underwriters take into consideration the effect of extraordinary, one-time events on your income. For instance, if you owned a restaurant in 2020 during the worldwide pandemic, your income that year was obviously lower.
Lenders look at this type of event as an external shock that is not likely to repeat and give you the benefit of the doubt when calculating your income. In the above example, the lender may take your 2021 restaurant income as more representative of ongoing performance.
How to calculate K1 income for a mortgage
A K1 is important because it shows the lender how much ownership interest you have in the company. If more than 25%, you are considered self-employed and will need to supply personal and business tax returns.
According to Fannie Mae, “Ordinary income, net rental real estate income, and other net rental income reported on Schedule K-1 may be included in the borrower’s cash flow.”
However, Fannie Mae follows this statement requesting that lenders verify that the business is in a solid enough financial position to be making these payments.
If you receive $50,000 per year from a business making $25,000, the lender will probably not allow you to claim this as real income, as it’s unsustainable.
When in doubt, send your full tax return records for the previous two years to a loan officer for review.
How long must you be self-employed?
The general rule is that you need to be self-employed for at least 24 months. They will look to document this history through a variety of sources, including two years’ income tax returns, a letter from your CPA, or a copy of a business license.
The reason for the two-year requirement is that lenders view income from self-employment as less predictable than for salaried borrowers. New businesses often fail. A person who has two years under their belt is less likely to fail than someone who is brand new to owning their own business.
They will then average your income over that two-year period.
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Self-employment less than 2 years
Lenders may accept shorter time frames, though. They may consider income if you have been self-employed for between 12 and 24 months, but never less than 12 months.
Borrowers with between 12 and 24 months’ history will provide their most recent income tax return, clearly demonstrating that they have received self-employment income for the entire 12 months covered by the return.
The lender will also verify employment over the previous 24 months and make sure you didn’t change career fields when you went self-employed.
You need to have one or, preferably, more years in the same line of work prior to starting your own business.
For instance, someone who was a staff writer at a news agency, but then started as a freelance writer, may be approved for a mortgage with solid income history before and after the transition.
FHA loans are most lenient for those with less than two years’ self-employment history.
Documentation requirements for the self-employed
Expect to provide at least your most recent income tax return, and very possibly your returns for the past two years. The lender’s automated underwriting system will determine whether you need one or two years’ tax returns; there’s no way to predict what you will need until you apply and the lender runs the scenario through the system.
You also may need business tax returns if your business is a partnership, a corporation, and “S” corporation or an LLC.
Any tax returns required must be signed and complete with all schedules included.
The lender may waive the business tax return requirement if the following apply:
- You’re using your own personal funds – and no funds from your business – to cover the down payment and closing costs
- You’ve been self-employed in the same business for at least five years
- Your individual income taxes show a pattern of steady increases in your income from self-employment over the past two years.
Special note about the 4506-T
Lenders require that you sign an IRS Form 4506-T, Request for Transcript of Tax Return. This form will be used to obtain copies of the tax information you have on file with the IRS. Lenders are confirming that the tax returns you’re using for qualification match those filed with the IRS. This is an effort to prevent the use of fraudulent income tax returns so be aware that you may face unpleasant consequences if the IRS transcripts don’t support those tax returns.
Sometimes people re-file taxes. In this case, give your lender the re-filed returns, because your previous returns won’t match the IRS tax transcripts.
Lenders typically can’t use the 4506-T in lieu of tax returns. Its purpose it to verify what you’ve submitted.
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Using business assets for the down payment on the new home
If you are withdrawing money from your business to cover your down payment or closing costs, the lender will have to evaluate the effect of that withdrawal on your business.
For example, the lender may request verification of all of your business’s financial assets to assess the impact of the withdrawal. The determination will be different in each case. For example, if your business has $100,000 in cash assets, and you need to withdraw $10,000, it may not be an issue. But withdrawing $80,000 could compromise the survival of your business.
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In that situation, the lender will likely request a written opinion from your CPA on the effect of the withdrawal on the business. If the CPA indicates that the withdrawal won’t hurt the business, the lender may allow the withdrawal. But the lender may put the loan approval on hold if the CPA indicates any concerns, or refuses to comment.
If you’re self-employed, it’s important to provide the necessary documentation and to do so as early in the loan process as possible. (Read more about this at our post “Ultimate Guide to Getting a Mortgage When You’re Self-Employed” for more) The lender isn’t looking to hassle you or to decline your loan. But they will need your help in supporting their decision to approve your loan. You’re helping your own cause by being fully prepared to cooperate.
Getting approved as a self-employed person
Lenders approve self-employed people for mortgages every day. There’s no reason to fear applying. The worst-case scenario is that you find out what areas you need to work on to be approved.