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Best Mortgage If Self Employed With Increasing Income

What is the best mortgage program for a self-employed borrower with increasing monthly income? Do I need to wait until the higher income is reflected on my tax returns or are there other programs that enable me to qualify for a higher loan amount sooner.

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

For standard self-employed borrower mortgage programs, such as conventional and FHA loans, your income when you apply for the loan is based on your tax returns for the prior two years. Lenders average your income as reported on your tax returns for the two year period and divide by twelve to calculate the monthly gross income used to determine what size mortgage you qualify for.

For example, if you earned $60,000 last year and $50,000 the prior year, your average income over the two year period is $55,000 -- dividing that figure by twelve months equates to $4,583 in average monthly gross income.  Only one year of self-employed tax returns may be required if you previously worked in a similar field and currently earn a similar or greater income but the income calculation works the same way.

Because lenders use your tax returns, they base the mortgage you can afford on your income for the prior calendar year rather than your current monthly income.  So if you apply for a mortgage in July 2020, lenders look at your income for the calendar year that ended December 2019 -- and most likely the 2018 calendar year as well.  Your income for the first half of 2020 does not really factor into your loan application because it is not reflected in your most recent tax return.   

For self-employed borrowers whose incomes increase significantly over the course of the year, this guideline means that they need to wait until the following year, after their returns are filed, to benefit from the increase in income. Returning to the example above, if your monthly gross income increases significantly during the first six months of 2020, you likely need to wait until 2021, when your 2020 tax returns are prepared, to apply for a mortgage, if you want to use the higher income amount.  

Most borrowers would prefer not to wait several months to apply for a mortgage but they may not qualify for the loan amount they want unless they have an additional year of tax returns.  Even then, with a standard self-employed mortgage program, lenders average the prior two years so you do not receive the full benefit of your higher income.  

Your alternative to using a standard program is to use a bank statement mortgage program. As the name suggests, bank statement programs enable you to qualify for a mortgage based on your bank statements instead of your tax returns and W-2s, which is why they are popular with self-employed applicants.

Although some programs require 24 months, many bank statement programs only require twelve months of statements to verify your income.  Additionally, you can use bank statements for the most recent twelve months to qualify instead of your tax return for the prior calendar year.

Review How a Bank Statement Mortgage Works

For example, if you apply for a mortgage in July, your income is based on the first six months of that year and the last six months of the prior year.  This means that a bank statement mortgage may enable you to benefit sooner from an increase in your income.

The downsides of a bank statement loan are that they typically charge a higher mortgage rate plus the qualification guidelines can be more challenging in certain areas. For example, the required down payment for most bank statement programs is 10% or higher for borrowers with lower credit scores, as compared to the 3.0%  or 3.5% down payment required for a conventional or FHA mortgage, respectively.  Additionally, paying a higher interest rate reduces what size mortgage you can afford, so there is a trade off as compared to standard mortgage programs.

We recommend that you contact multiple lenders to compare loan terms for both standard self-employed and bank statement loan programs.  When you speak with lenders it is important to understand the mortgage you qualify for depending on the program you choose.

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You can also use the FREEandCLEAR Lender Directory to search by location and loan program. For example, you can search for top-rated lenders in your state that offer bank statement loans or mortgages for self-employed applicants.

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Sources

"B3-3.2-01, Underwriting Factors and Documentation for a Self-Employed Borrower."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, December 4 2018.  Web.

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About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR.  Harry is a licensed mortgage professional (NMLS #236752). More about Harry

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