Being self-employed can be great, but before you quit your salary job, you should be absolutely sure that you will not need a mortgage in the next 2-3 years.
Lenders have very strict rules with regards to documenting income for a self-employed person.
In order for the income from the business to be eligible as “qualifying income” on a loan application, the business has to have a track record that can be verified. In most cases, a 2 year history of filed federal tax returns showing the business income will do the trick, but there is more to consider that just that.
- Many times, the first year or two of a new business can be rocky. If that is the case, the income may not even be enough to qualify for a mortgage. When analyzing business income from a federal tax return (schedule C), underwriters look at the adjusted income after expenses. This amount is then averaged over the most recent two years (using 2 years of filed federal tax returns) to determine the average income. If the income has increased each year, the total can be averaged over 2 years, however if the most recent year income is less, that years income must be used.
- 1099 income is always categorized as self-employed income. 1099 income does not withhold any state/federal taxes, unlike w2 income, which does. If you switch from receiving a w2 to receiving a 1099, you are then immediately considered self-employed. (This only matters if the 1099 income is for your primary job and this income is needed to qualify. If 1099 income is from a secondary job that is not needed for qualifying, the 1099 income would not matter).
- Filed federal tax returns are always required to document self-employment. If you have not filed taxes, your income is not eligible until the IRS has confirmed you filed and owed taxes have been paid, or payment arrangements have been made.
- S-Corp or Partnership returns for the most recent two years may also be required, depending on the borrower’s % ownership of that business. 25% or greater ownership will require copies of the full business returns for those years.
A lot can happen over a 2-3 year period, so if there is any chance of needing to sell your home, buy a home, refinance, or take out a home equity line of credit in the next few years, be sure to check with your loan officer for guidance before you quit your current job. A little planning can go a long way.
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***Tax implications should be considered with self-employment. Be sure to speak with your CPA for guidance***