Can I Get a Conventional Loan if I’m Self-Employed?

Getting a conventional loan when you're self-employed is often considered complicated, but it doesn't need to be. You will have to provide more paperwork than a traditionally-employed applicant, although the process is relatively easy if you're prepared.

Here’s what lenders expect from self-employed business owners and what you can do to maximize your chances of being approved for a conventional loan.

How Long Do You Have To Be Self-Employed?

Conventional lenders are looking for two years of self-employment. But in reality, owning your business for that long isn't enough. You're going to need two full years of filed tax returns. You could be looking at up to three years in total, depending on when you started your company.

An example:

You founded your business in June, the tax return for the first six months of operations won't qualify. You will need two full years after that (unless you made a ton of money from June to December the first year).

Then you might work two more years to show steady income from the new business. That’s two and a half years so far.

If you file your taxes for that second full year at the April deadline, you'll be self-employed for nearly three years before having the documentation you need to qualify for a conventional mortgage.

Plus, those two full years of filed tax returns must report adequate income to qualify you for a loan. It's not uncommon for new businesses to take time to ramp up revenue. If your first year's income was sub-par, you may need to wait until you have two years of consecutive, consistent income.

Are There Exceptions to Two Years of Self-Employment?

Yes! Lending guidelines allow borrowers to qualify if they’ve recently transitioned into self-employment from the same industry or profession. If, as an example, you are a doctor who just opened your own practice or an accountant who became an independent contractor, loan officers may consider tax returns including income from W-2s.

You’re still required to have a minimum of 12 months of self-employment, however, and your income levels need to be comparable or growing.

Proof of Self-Employment

Because of the uniqueness of every self-employed borrower's finances, loan officers require more paperwork than with traditionally-employed applicants.

The most common proof of self-employment you will need to provide includes:

Individual and Business Tax Returns

As mentioned above, lenders will require two years of filed tax returns. The forms needed for your business will depend the structure of your business. Sole proprietorships and fully-owned LLCs will require a Schedule C, while other types of ownership may require Form 1065, Form 1120, or Form 1120-S (Schedule K-1).

Some lenders may not request business tax returns if you:

• Have owned the same business for more than five years
• Show year-over-year income growth on your two most recent individual tax returns
• Are not using business funds for your down payment or closing costs.

Profit and Loss Statement

Although not always needed, a lender may require a profit and loss statement for the current year. This is typically when applying for a conventional mortgage more than 120 days after the end of the last tax period.

CPA Letter

As a self-employed borrower, you'll need to provide a letter from a CPA stating that they've examined (or prepared) your company's tax filings and that your business is still a going concern. This is often called a comfort letter because it provides lenders independent verification of your financial situation.

Conventional Loan Red Flags for Self-Employment

When conventional loan underwriters analyze a self-employed applicant’s finances, there are a handful of red flags that they’re on the lookout for:

Income Is Decreasing

Lenders prefer to see your income level growing year after year. If you've earned the same over the past two years, that's alright too. But if your most recent tax return shows a decrease in income, expect a little extra scrutiny.

Your Industry/Profession Is in Decline

Even if your business financials are good, lenders will want to take a deeper look at your business’ future outlook if you’re in an industry or profession that’s in decline. This can be a cyclical decline, like a commercial real estate agent in the current work-from-home era, or, to look at examples from the past, a fax machine salesperson or physical newspaper publisher.

Missed Payments/Cash Flow Problems

Ultimately, lenders want to ensure you can repay your loan and meet debt obligations on time. If you've recently missed personal or business debt payments or over-drafted your bank accounts, plan for a deeper analysis of your cash flow.

Avoid Too Many Write-Offs

When tax season comes around, self-employed filers rarely hesitate to take any deduction available. These write-offs are terrific when cutting your check to the government but far less helpful if you're trying to get a conventional loan.

The number one problem that self-employed applicants face when applying for a conventional loan is that they've taken too many business write-offs. Lenders calculate your ability to afford a loan based on after-expense business income. Generally speaking, that’s the amount you pay taxes on.

Some deductions, referred to as add-backs, won't negatively impact your income level when getting a mortgage. These are typically write-offs that aren't cash expenses. The most common add-back is depreciation, which is added back to your taxable income for calculations.

More Advice for Self-Employed Conventional Loan Applicants

Here are a few more pieces of helpful advice for self-employed conventional loan applicants:

• Nearly all conventional lenders require your debt-to-income ratio (DTI) to be below 45%. That means 45% of your gross income is required for your future home payment plus all other debt payments. Many even need your DTI no higher than 43%. Optimally, Fannie Mae recommends borrowers maintain a DTI of 36% or lower.
• Most lenders don't consider (meaning they will exclude from DTI calculations) installment loans with ten months or fewer of payments remaining. For instance, they may disregard a $500 car payment on a $4,000 balance.
• If your year-over-year income is increasing, loan underwriters will use the average of the two years for calculations. If your tax documents show your income is decreasing, they'll only use the more recent, lower income.

Apply To See if You’re Eligible for a Conventional Loan

Figuring out if you can get a conventional loan as a self-employed business owner is not as easy as it is for other applicants. Traditional eligibility calculators simply don’t work.

The best way to determine if you qualify for a conventional mortgage is just to apply. Lending professionals make the preapproval process as straightforward as possible, and even if you aren't eligible, they can give you a much better idea of what you need to do to get there.