How does a lender calculate 1099 income
Guide to how does a lender calculate 1099 Income for Mortgage Qualification
The 1099 Only mortgage product is specifically designed for self-employed workers or independent contractors who receive compensation in the form of commission or contractor pay and receive IRS Form 1099 at year end. These non qm loans are crucial for individuals—such as freelancers or business owners—whose income might not be accurately reflected by their tax returns due to high write-offs.
Eligibility and Documentation Requirements
A. Borrower Eligibility
For a borrower to be eligible for a 1099 income calculation, their primary income source (>50% of qualifying income) must be derived from the 1099 income stream after applying the necessary expense ratio.
- Work History: Borrowers must generally have a two-year employment history in the same line of work and must have received 1099 income for at least one year. Some lenders may permit qualification with only one year of 1099 income.
- IRS Verification: We require the Wage & Income Transcripts for the year(s) of qualifying income. The W-2s and 1099s provided by the borrower must be verified by the IRS.
- Required Documentation: The loan file must include the most recent one or two years of 1099(s) and documentation of Year-to-Date (YTD) earnings to support the ongoing receipt of income. This YTD documentation can include payroll registers, a Written Verification of Employment (WVOE), or equivalent third-party documentation such as bank statements.
- Ineligibility: Borrowers who are paid by multiple 1099s are generally classified as self-employed and must qualify using 12- or 24-month bank statements instead of the 1099 Only program. Rideshare drivers (such as Uber and Lyft) are explicitly ineligible for the 1099 program under certain guidelines.
Income Calculation Methodology
Qualifying income is based on the gross 1099 earnings less an applicable expense ratio. The ratio used depends on the level of documentation provided by the borrower.
A. Standard Expense Factor (Fixed 10%)
This is the most common method when specific business expense information is not provided.
- Fixed Ratio Application: A 10% expense factor is applied to all eligible gross receipts. This means the qualifying income is calculated as 90% of the gross 1099 earnings.
- Income Calculation Formula: The stable monthly income is calculated by taking the YTD earnings plus prior year(s) 1099 earnings and dividing by the applicable number of months.
- Averaging: If two years of 1099s are used, a 24-month average of net income is utilized in the event of stable or increasing gross receipts. If the gross receipts are declining, a 12-month average of net income from the most recent year must be used.
B. Third-Party Prepared P&L or Expense Letter
Alternative methods are permitted, particularly under our Connect guidelines, to utilize a more accurate expense ratio than the fixed 10%:
- Profit and Loss (P&L) Statement Method: A CPA, EA, or licensed tax preparer prepared P&L statement is utilized,. The gross receipts on the 1099s must support at least 90% of the gross receipts listed on the P&L. If this support is met, the net income on the P&L is used as the qualifying income.
- CPA Expense Letter Method: A CPA, EA, or licensed tax preparer provides a signed letter that states the borrower’s expense ratio based on their review of the most recent year’s tax returns,. This expense ratio is then multiplied by the gross receipts shown on the 1099s, and the resulting expense figure is deducted from the gross receipts to determine the qualifying income.
Special Scenarios
A. Income Paid to an LLC
If the 1099 is paid to a business entity (like the borrower’s LLC) instead of the individual, it is acceptable provided the borrower’s ownership interest in the entity is 100%. In this scenario, we must apply a 15% expense factor. This requires a CPA letter verifying that the LLC is 100% owned by the borrower and is active.
B. Recent W-2 to 1099 Transition
A borrower who recently transitioned from W-2 employment to 1099 contracting may be eligible without a full two-year 1099 history, provided they meet several conditions:
- They must be with the same employer for at least two years or in the same industry with a similar role.
- The employer must provide a contract.
- The employer/contract must either indicate the borrower will not be responsible for any job-related expenses, or a 10% expense factor will be applied.
- The underwriter should utilize the borrower’s last two years’ W-2 income (less any 2106 expenses claimed) to establish an average income which the new P&L should support.
FAQ's
The standard uniform expense factor applied is 25% to all eligible gross receipts under our Connect Method One.
The underwriter should utilize the borrower’s last two years’ W-2 income (less any 2106 expenses claimed) to develop an average income that the new 1099 income should support.
Evidence of Year-to-Date (YTD) earnings is required (usually within 90 or 120 days of the note date) via documents such as a payroll register, check stubs showing YTD totals, or bank statements showing receipt of income.
Wage & Income Transcripts (4506-C) for the year(s) of qualifying income are generally required to verify the 1099s/W-2s.
A 15% expense factor must be applied to the gross earnings.
A 12-month average of net income from the most recent year must be utilized. Declining income sources should be closely reviewed and may not be used if the trend has not stabilized.
The income is calculated by taking the YTD earnings plus prior year(s) 1099 earnings and dividing by the applicable number of months. A 24-month average of net income is used if gross receipts are stable or increasing.
This fixed factor is generally intended for borrowers with no office space, employees, or cost of goods sold.
A common fixed expense factor is 10%. This means the resulting qualifying income is 90% of the gross 1099 earnings.
The lender must apply an expense factor (or expense ratio) to the gross 1099 earnings to determine the net income available for repayment.
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