Qualify for a mortgage if self-employed and use significant business write-offs that minimize my taxable income
Qualify for a mortgage if Self-Employed with Significant Business Write-Offs
The Challenge of Qualifying with Traditional (QM) Loans
For self-employed individuals, including small business owners, entrepreneurs, contractors, and freelancers, the primary hurdle in securing a mortgage is the reliance of Qualified Mortgages (QM) on documented taxable income.
- Taxable Income vs. Cash Flow: Self-employed borrowers frequently claim significant tax deductions and write-offs. While these deductions are legal and beneficial for tax purposes, they substantially reduce the borrower’s Adjusted Gross Income (AGI) reported on federal tax returns (1040s and Schedule C/E). This reported income may be insufficient to qualify for a traditional loan, even if the borrower’s actual cash flow is robust.
- QM Requirements: Traditional QM loans require consistent income verification via W-2s, pay stubs, or tax returns. Furthermore, QM loans generally limit the borrower’s debt-to-income (DTI) ratio to 43% or less.
- Non-QM Solution: Non-QM loans provide flexible documentation options designed for borrowers whose income structure does not fit the standard mold. These loans are underwritten based on the borrower’s ability to repay (ATR), typically proven by demonstrating reliable cash flow through alternative documentation.
Non-QM Alternative Income Documentation Programs
The most effective solutions for self-employed borrowers seeking to bypass tax return reliance are the Bank Statement Loan, the 1099 Only Loan, and the P&L Statement Loan.
1. Bank Statement Loans (BSL)
Bank Statement Loans are designed for self-employed individuals who are actively running a U.S.-based business and generating stable revenue. These loans allow the borrower to verify income using 12 or 24 months of consecutive personal or business bank statements instead of tax returns.
A. Business Bank Statement Qualification:
When using business bank statements, we must determine the business’s actual income by accounting for expenses.
- Fixed Expense Ratio: Many programs allow all businesses to qualify using a fixed expense ratio, often 50%. We calculates the average eligible deposits and reduces this figure by the fixed expense factor to determine the qualifying net income.
- Third-Party Prepared Statements: Alternatively, qualifying income can be determined using a Profit and Loss (P&L) statement or a letter from a licensed tax professional, such as a CPA or Enrolled Agent (EA), which provides the business’s specific expense ratio. The expense ratio must be deemed reasonable for the business type. In some programs, the minimum expense ratio allowed when stated by a third party is 20%.
- Calculation: The calculated income is typically applied to the borrower based on their ownership percentage (e.g., if net income is $10k/month and the borrower owns 65%, their qualifying income is $6,500).
B. Personal Bank Statement Qualification:
- Income Source: Only transfers or deposits from the business account(s) are considered eligible deposits when calculating income from personal bank statements.
- Exclusions: Any deposits deemed to derive from a source other than the business (such as rents, SSI, or transfers between personal accounts) must be excluded from the analysis.
Note on Documentation: If a borrower provides tax returns or tax transcripts, the loan generally becomes ineligible for the Bank Statement program and must be underwritten based on Full Documentation guidelines, which would likely defeat the purpose of avoiding the effects of large write-offs.
2. 1099 Income Only Loans
This product is specifically designed for independent contractors or commission earners who receive compensation documented via IRS Form 1099.
- Basis for Income: We review one or two years of 1099s.
- Fixed Expense Ratio: Qualifying income is determined by applying a fixed expense ratio to the gross receipts reflected on the 1099s. A common uniform expense factor of 10% is deducted from the gross 1099 earnings to determine net qualifying income.
- Primary Income Source: For eligibility, the income derived from the 1099 calculation must generally constitute the borrower’s primary income source (e.g., >50% of qualifying income).
3. Profit and Loss (P&L) Statement Loans
Some Non-QM programs allow self-employed borrowers to qualify using a P&L statement prepared by a third party, such as a CPA, EA, or licensed tax preparer.
- Requirements: The P&L must typically cover a 12-month period. In many cases, the professional preparing the P&L must have also filed the borrower’s most recent business tax returns.
- Calculation: Qualifying income is calculated based on the net income from the P&L, generally divided by 12 months, and then multiplied by the borrower’s ownership percentage.
- Non-Cash Addbacks: Adjustments may be allowed for non-cash expenses listed on the P&L, such as depreciation, depletion, and amortization/casualty losses, which may be added back to the net income to increase the borrower’s qualifying income.
General Self-Employed Qualification Parameters
Regardless of the alternative documentation type used (Bank Statement, 1099, or P&L), self-employed borrowers must meet specific operational history and ownership requirements:
| Requirement | Criteria |
| Self-Employment History | Generally, a minimum of two years history in the current business or profession is required. Less than two years (but not less than one year) may be considered if the borrower has sufficient prior experience (e.g., two years or more) in the same line of work. |
| Ownership Verification | The borrower is typically considered self-employed if they have an ownership interest of 25% or greater. This must be verified by a third party (CPA/tax preparer) or legal documents (Operating Agreement, Articles of Incorporation). |
| DTI Flexibility | Non-QM loans often allow a higher maximum Debt-to-Income (DTI) ratio, typically up to 50%. Some programs may allow DTI up to 55%. |
| No Tax Transcripts (Alt Doc) | For Bank Statement and DSCR programs, tax returns and tax transcripts (IRS Form 4506-C) are generally not required. If tax returns are provided, the loan may be rendered ineligible for the alternative program. |
FAQ's
While Qualified Mortgages typically cap the DTI at 43% or less, Non-QM programs are more flexible, often allowing DTI ratios of 50% or lower. Some programs for self-employed borrowers accept DTI ratios up to 55% or 60%.
Borrowers generally must have been self-employed for at least two years in the same business. Some programs allow for less than two years (but a minimum of one year) if the borrower has at least two years of previous history in the same line of work.
A 10% uniform expense factor will generally be applied to the eligible gross receipts from the 1099s to determine the qualifying income.
Yes, independent contractors or commission earners who receive compensation via Form 1099 can apply for a specialized 1099 Only loan. These loans utilize the 1099s supplied, minus an applicable expense ratio.
You can provide an Expense Ratio Statement prepared by a licensed CPA, Enrolled Agent (EA), or licensed Tax Professional, which specifies the business expenses as a percentage of gross sales/revenue. The minimum allowed expense ratio is typically 10% to 20%.
Lenders apply a uniform or calculated expense ratio to the gross deposits. For many business types, a fixed expense ratio of 50% may be applied to calculate the net qualifying income.
Lenders typically require reviewing the last 12 or 24 months of bank statements to determine the borrower’s average monthly deposits and cash flow.
Bank Statement Loans are the most common alternative, allowing self-employed borrowers to qualify using their personal or business bank statements to show cash flow instead of tax returns.
You should pursue a Non-Qualified Mortgage (Non-QM). These non-traditional loans offer flexible documentation options that are designed for self-employed individuals and those with unique income-qualifying circumstances.
Traditional (QM) lenders rely on tax returns, W-2s, or pay stubs for qualification. When you utilize significant business write-offs (deductions), your taxable income (Adjusted Gross Income) is reduced, which makes it harder to prove sufficient income to qualify for a traditional loan.
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