If you own 25% or more of a business, the FHA considers you self-employed. This puts you in a different category when it comes to verifying your employment and income. The FHA has strict rules you must follow in order to qualify using your self-employment income.
Time in Business
The first thing you must verify is the length of time you have been self-employed. The longer you own your business, the more likely it is to succeed. Generally, the FHA requires borrowers to own their business for at least 2 years before applying for an FHA loan.
You’ll need your business license and a letter from your CPA stating how long you have been in business. If you have been in business for yourself between 1 and 2 years, you’ll also need proof of previous employment in the industry. You can do this with a paystub and/or W-2 from your job in the same line of work. The FHA wants proof that you have the knowledge and experience necessary to make the business work with such a short history of self-employment.
If you have been in the business for less than 1 year, no documentation is necessary. The FHA generally will not approve a borrower with self-employment income until they have at least 1 year of experience under their belt.
Proving your income is the hardest part of being self-employed. Generally, the FHA would like the last two years of your tax returns. This includes all schedules and the tax returns must be signed by you. If you operate as an ‘S’ corporation, you’ll need a copy of your business tax returns with all schedules as well.
You will also need to provide a year-to-date Profit & Loss Statement or Balance Sheet. This shows the lender how your business is doing this year compared to the income you reported on your tax returns from the previous two years.
The FHA lender will determine if they should use the income reported on your current P&L through this year or if they will use the income strictly from your tax returns.
- If your income on your P&L is much higher than the income on your tax returns, the lender will use just your income tax return income, as there is nothing to support the higher income.
- If your income on your P&L is much lower than the income on your tax returns, the lender will use this income for qualifying.
Stable Income for the Self-Employed
The most concerning factor regarding the self-employed is the stability of the income. If you work for yourself, it’s important that you set up a good track record in regards to your income. You’ll want to show a lender an increasing trend as far as receiving your income. If you have years of ups and downs, it will show inconsistency to a lender. Rather, wait until you have at least 2 years of stable or increasing income before you apply.
It’s also best if you have compensating factors. The FHA considers the self-employed borrower risky. That’s not to say that they don’t write loans for those owning their own business. However, they may want to see higher credit scores or lower debt ratios than they normally allow to make up for the risk. Of course, if you own a business in a steady industry, that helps as well.
The lender has the responsibility of making sure you are a good risk. Anything you can do to prove that will help your case being self-employed. Great credit, sufficient assets, and minimal debts are three great ways to improve your chances of approval as a self-employed borrower.