Self-Employed Borrowers
Self-employed borrowers
Including small business owners, contractors, freelancers, and gig workers—constitute a primary and rapidly growing demographic that Non-Qualified Mortgage (Non-QM) products are specifically designed to serve.
These individuals often struggle with traditional mortgages because their complex finances, heavily reliant on business deductions and fluctuating cash flow, do not align with the rigid W-2 and tax return requirements of conventional lending.
Here is a comprehensive overview of how self-employed borrowers are addressed, focusing on specialized Non-QM income verification methods.
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The Challenge for Self-Employed Borrowers
The traditional mortgage system requires stable, consistent income documentation, typically looking at two years of W-2s and tax returns. Self-employed individuals typically face hurdles in this process:
- Tax Write-offs: Business owners, entrepreneurs, and contractors often claim significant tax deductions and write-offs to lower their taxable income. This reduction in taxable income makes it difficult or impossible for them to qualify for a conventional loan, even if their actual business cash flow is robust.
- Irregular Income: Freelancers and gig workers may have fluctuating, seasonal, or inconsistent income streams that do not present a clear, steady picture on standard tax forms.
Non-QM loans offer a “flexible path to homeownership” by accepting alternative documentation to verify the borrower’s Ability to Repay (ATR).
Non-QM Income Verification Options
The core of Non-QM lending for the self-employed lies in using their cash flow instead of their tax returns. The following programs are specifically designed for this group:
1. Bank Statement Loans (Personal or Business)
Bank statement loans are often described as the perfect solution for self-employed professionals, contractors, and small business owners.
- Mechanism: We evaluate the borrower’s bank statements (typically 12 or 24 months) to determine the average monthly deposits and consistent cash flow, bypassing the need for W-2s or tax returns.
- Eligibility: At least one borrower on the file must derive their primary income source from self-employed activity, defined as having 25% or greater ownership in a business.
- History Requirement: Borrowers generally must be self-employed in the same business for a minimum of two consecutive years. A history of less than two years (but not less than one year) may be eligible with a written explanation, additional reserves (e.g., six months), and documentation of at least two years of previous experience in the same line of work or related field.
- Documentation Required:
- Bank Statements: 12 or 24 months of consecutive statements are required. The most recent statement should be no older than 30 days from the application date.
- Business Existence: Verification of the business’s existence and active operation is required (e.g., Business License, Letter from CPA/Tax Preparer/Regulatory Agency, Secretary of State Filing, or equivalent documentation). This verification must be within 30 days of the note date for Horizon products or 10 business days for Sharp products.
- Business Narrative: A signed written business narrative detailing the business operation, products/services, customer base, and number of full-time employees is often required.
2. Bank Statement Income Calculation Methods
The method used to calculate income depends on whether personal or business bank statements are utilized, and typically involves deducting an expense factor.
| Method | Details |
| Personal Bank Statements | Typically involves calculating income based on the total eligible deposits. Transfers from a business account to a personal account may be included. Deposits from non-business sources (like rents, SSI, or IRS refunds) must be excluded. Some programs (e.g., Edge) allow 100% of business deposits into a personal account to be used if the borrower maintains a separate business account and owns at least 20% of the business. |
| Business Bank Statements | Requires applying an Expense Ratio to the gross deposits to determine net qualifying income, based on the borrower’s ownership percentage (minimum 25% or 50% depending on the program). |
| Fixed Expense Ratio | A standard percentage is applied across most business types, often 50%. In Edge programs, smaller service businesses (e.g., consultants) might be eligible for lower factors, such as 30% or 20%. |
| Third-Party Prepared P&L/Expense Ratio | We uses a net income or expense ratio provided in a P&L or letter prepared by an independent CPA, Enrolled Agent (EA), or licensed tax preparer (PTIN/CTEC). This often requires the preparer to attest they have filed the borrower’s most recent tax returns. |
3. 1099 Income Loans
These programs target independent contractors, freelancers, and commission earners who receive IRS Form 1099.
- Eligibility: The borrower must generally have a two-year employment history in the same line of work, with at least one year of receiving 1099 income. The 1099 income must represent the borrower’s primary income source (>50% of qualifying income).
- Documentation: Requires the actual 1099 forms (1 or 2 years), proof of year-to-date (YTD) earnings, and often tax transcripts.
- Income Calculation: Qualifying income is calculated based on the 1099 total minus a business expense factor.
- Fixed Expense: A 10% expense factor is commonly applied to gross 1099 earnings.
- Multiple 1099s: Borrowers paid by multiple 1099s are considered Self-Employed and must qualify using the more detailed 12- or 24-month bank statement program.
- W-2 to 1099 Transition: If a borrower recently transitioned from W-2 to 1099 with the same employer, they may qualify without a full two years of 1099s if the employer confirms they are not responsible for additional expenses (i.e., via contract).
4. Full Documentation (Tax Returns)
For self-employed borrowers who do not write off excessive expenses or whose income is stable, the Full Doc option is available, requiring two years of documentation.
- Documentation: Two years of signed personal and business federal tax returns (including all schedules and K-1s), along with a Year-to-Date (YTD) Profit and Loss (P&L) statement. Tax Transcripts are typically required.
- Income Calculation: Income is calculated using the Fannie Mae Cash Flow Analysis (Form 1084) or equivalent. Certain non-cash expenses like Depreciation, Amortization, and Business Use of Home can be added back to the income calculation.
5. P&L Statement Only
The P&L Only program allows self-employed borrowers to qualify using a P&L statement prepared by a CPA/EA/CTEC, provided the borrower does not file their own tax returns.
- Requirements: Requires a minimum of two years of self-employment in the current profession and minimum 50% ownership in the business.
- Calculation: The net income from the P&L (covering 12 or 24 months) is divided by the number of months, then multiplied by the borrower’s ownership percentage. P&Ls must adhere to minimum expense ratios (e.g., 15% minimum or higher, depending on the business type).
General Requirements for Self-Employed Borrowers
- Business Verification: The existence of the business must be verified through a third party (CPA, regulatory agency, phone listing) within 30 days of the note date.
- Declining Income: If a borrower’s income trend is declining, the lower income amount, or the income after stabilization, must be used to qualify. A signed Letter of Explanation (LOE) from the borrower is required to explain the decline.
- Business Debt Exclusion: If a self-employed borrower has business debt listed on their personal credit report (e.g., auto loan, business credit card), that debt may be excluded from the personal DTI ratio if the borrower provides evidence (e.g., six months of company checks or business bank statements) that the business is paying the obligation and this payment was accounted for in the cash flow analysis.
- Cannabis Industry: Borrowers employed in the Cannabis industry are considered on a case-by-case basis. Self-employed borrowers deriving income from any Cannabis related business are ineligible in the Sharp series and River series.
- Credit Scoring: For most non-DSCR programs, the qualifying credit score is the representative score of the primary wage earner. If borrowers have a 50/50 ownership split in the business, the highest representative score is often used.
Investor Self-Employed Borrowers (DSCR)
For investors, the DSCR loan offers the most straightforward path by completely ignoring personal income and self-employment status.
- No Income/Employment Verification: Since the loan qualifies based on the property’s cash flow (Gross Rent / PITIA), borrower employment and income are not verified.
- Eligibility: Self-employed individuals are specifically noted as prime users of DSCR loans for investing in rental or short-term rental properties.
FAQ's
Yes. Self-employed borrowers can sometimes qualify using a Profit and Loss (P&L) Statement Only loan, which requires a P&L prepared by an independent Certified Public Accountant (CPA) or Enrolled Agent (EA). Additionally, if the self-employed borrower is asset-rich, they may qualify using an Asset Depletion Loan, which converts liquid assets into qualifying income instead of focusing on their traditional earnings or cash flow.
Yes. Lenders require independent verification that the borrower’s business is active and fully operational. This verification must usually occur within a short window prior to the note date (e.g., 10 to 30 calendar days before closing) using third-party sources such as a CPA, regulatory agency, licensing bureau, or a phone/internet listing that confirms the business address and status.
Yes. Borrowers using Bank Statements or 1099s to calculate their primary income (must be >50% of qualifying income) may generally supplement their income with other sources like Social Security, Pension, Alimony, Child Support, and Second Job income. These supplemental sources must be documented according to full documentation guidelines, but tax returns are not provided in Alt-Doc scenarios.
Independent contractors, freelancers, and commission earners who receive IRS Form 1099 can qualify using their 1099 forms (typically for the last 1-2 years) and YTD documentation. Qualifying income is calculated based on the gross 1099 receipts minus an expense factor, commonly set at a fixed 10% expense factor (meaning 90% of gross 1099 earnings are used).
Borrowers generally must have been self-employed in the same business for a minimum of two consecutive years. However, some programs may consider applicants with less than two years but not less than one year if they can document a minimum of two years of previous experience in the same line of work or related profession, or provide evidence of formal education in the field.
Lenders analyze 12 or 24 consecutive months of bank statements (personal or business) to determine the borrower’s average monthly income and financial reliability. If personal bank statements are used, lenders calculate the qualifying income based on total eligible deposits. If business bank statements are used, a business expense factor must be applied to the gross deposits (often a fixed 50% ratio for most business types) to derive the net qualifying income.
The most popular Non-QM options designed to provide flexible income documentation for the self-employed are Bank Statement Loans and 1099 Income Loans. These loan programs offer alternative underwriting methods that look at cash flow and assets instead of relying solely on W-2s or tax returns.
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