The Self-Employed Borrower Breakdown

Written By: Frankie Lacy

Do you ever wonder how to determine if a borrower is self-employed? Do you want a better understanding of how self-employment income is reviewed? This article is for you! First, let’s define the self-employed borrower. A self-employed borrower earns income from a business in which they have 25% or more ownership interest.

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Self-employed borrowers should have the following:

  • 24 month history of self-employment regardless of prior work history
  • Tax returns showing a minimum of two years self-employment history
  • When tax returns do not show a complete 24 month history, a year-to-date profit and loss statement prepared by a CPA must be provided for the remaining time period

When reviewing self-employment income note that all sources of income included in the loan qualification must be stable. There needs to be a reasonable expectation that the same level of income will continue to be received for a minimum of three years. If you have reviewed the income and determined there is no indication the income source will stop within the next three years, it can be assumed that the income will continue.

Once you have determined that a borrower is self-employed you must collect all the required tax return documents and any additional documentation that will assist the underwriter in determining the correct monthly income. Regardless of whether self-employment income is used to qualify, tax returns must be collected. This is needed in order to determine if there are expenses to be reviewed or losses to be counted as liabilities.

In order to determine if a self-employed borrower’s income is stable they should have the following:

  • Minimum of two years operating the same business.
  • Demonstrate their ability to meet current and future obligations if they have fluctuating or diminishing income from their business. (Underwriter will determine through development of cash-flow analysis and business liquidity analysis.)
  • The processor needs to do an independent verification to show the borrower is self-employed.
  • The business needs to provide the borrower with a sufficient salary and/or distributions so that he or she can repay all of their debt.

The 1040’s (personal tax returns) provide information about what additional tax documentation is required. This information is needed to get a complete picture of the customer’s income and expenses associated with self-employment. Before the processor reviews the 1040’s they should verify that they received the correct form. They should also verify that they received the correct year and have the correct borrower information. The borrower’s information on the 1040’s should be consistent with the loan application and other documents in the loan file.

The processor should be aware that the 1040 tax form consists of two full pages not counting any attachments. The first page of the 1040 will collect information about the taxpayer, dependents, income items, and adjustments to income. It will also provide clues to what additional schedules are required.

The second page calculates the allowable deductions and credits, tax due given the income figures, and applies funds already withheld from wages or estimated payments made towards the tax liability.

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For more information about reviewing tax returns and calculating self-employment income check out the Mortgage University’s Advanced Loan Processing and Tax Return Analysis trainings.


About The Author

Frankie Lacy - As an active NAMP® member and a NAMU®-CMMU designee, Ms. Frankie Lacy is a 13-year mortgage industry veteran with extensive conventional mortgage underwriting experience. Frankie is also a mortgage instructor for Mortgage Underwriter University (www.MortgageUnderwriter.org). Topics of Frankie's expertise include: Fannie Mae, Freddie Mac, USDA Rural Housing, underwriting to investor overlays, self-employed borrowers, personal and business tax return analysis, rental income, condos/co-ops/PUDs, and more. Frankie is a Davenport University graduate with a degree in Business Administration. If you're interested in becoming a writer for NAMP®, please email us at: contact@mortgageprocessor.org.


Opinion-Editorial (Op-Ed) Disclaimer For NAMP® Library Articles: The views and opinions expressed in the NAMP® Library articles are those of the authors and do not necessarily reflect any official NAMP® policy or position. Examples of analysis performed within this article are only examples. They should not be utilized in real-world application as they are based only on very limited and dated open source information. Assumptions made within the analysis are not reflective of the position of NAMP®. Nothing contained in this article should be considered legal advice.