Buying a house while self-employed: a survival guide

The most common thing I hear from self-employed borrowers: "I make good money. Why is the bank saying I make less?"

Because a mortgage underwriter doesn't look at your revenue or your bank balance. They look at your taxable income, averaged over time. Every deduction that saved you money in April can cost you buying power when you apply.

What counts as self-employed

Generally, if you own 25% or more of a business, or you're paid on a 1099, underwriting treats you as self-employed. That includes sole proprietors, LLC owners, S-corp and partnership owners, and gig or contract workers.

The two-year rule

Most loans want two years of self-employment history, documented with two years of personal tax returns and, if you have one, business returns. In some cases one year of returns can work if you've been in the same line of work for longer.

Your qualifying income is usually the average of those two years. And if this year is lower than last year, underwriting may use only the lower number, or question whether the business is stable.

Add-backs: the deductions that come back

Some deductions don't represent cash leaving your pocket. Underwriters can add those back to your income:

• Depreciation on equipment, vehicles or property
• Depletion and amortization
• Business use of home on Schedule C
• One-time, non-recurring losses (with documentation)

Planning before you file

This is the most valuable thing I can tell you. If you're planning to buy in the next year or two, talk to me before your CPA files your return.

Your CPA's job is to lower your taxes. My job is to help you qualify. Sometimes those goals conflict. Taking a few thousand dollars fewer in deductions might cost you a little in tax and gain you $50,000 or more in buying power. Only you can decide whether that trade is worth it, but you should see the numbers before it's too late to change them.

The best time to plan a self-employed mortgage is before tax season, not after the offer is accepted.

What to have ready

1. Two years of personal tax returns, all pages and schedules
2. Two years of business returns (1120S, 1065 or 1120), if you file them
3. K-1s for any partnerships or S-corps
4. A year-to-date profit-and-loss statement
5. Two to three months of business and personal bank statements
6. Proof the business is active: a license, CPA letter or website

When tax returns don't tell the story

Some borrowers write off so much that their returns can't support the loan they can clearly afford. There are alternative programs, sometimes called bank statement loans, that qualify you on deposits instead of tax returns.

I'll be straight with you: those programs usually come with higher rates and bigger down payments. They're a tool, not a first choice. If one makes sense for you, I'll show you the full cost compared with waiting a year and qualifying traditionally.

Four habits that make approval easier

• Keep business and personal money in separate accounts.
• Avoid large cash deposits you can't document.
• Don't take on new business debt in the months before applying.
• Keep your year-to-date books current. Underwriting may ask.

Figures in this article are illustrative examples, not rate quotes. Your actual rate, mortgage insurance and costs depend on your credit, down payment, property and loan program. This is not a commitment to lend. All loans subject to credit approval and underwriting guidelines. Rates and terms are subject to change without notice.