With the changes in the mortgage industry, all homeowners and first time home buyers who apply for a mortgage loan have to verify their income. There are no more stated income or “liar” loans available.
Despite the hassle of getting copies of pay stubs and W2s, if you’re employed (and not self employed), the income calculation is pretty simple.
Year to date income and with-holdings are picked up on a pay stub as well as yearly earnings are shown on a W2 form.
For self employed home loan borrowers, it’s a different story altogether.
Many self employed people (and the definition of being self employed is if you own more than 25% of the business) don’t give themselves a pay stub or W2.
They simply take money out of a business account as they need to.
So how does a mortgage underwriter determine the self employed income?
Mortgage underwriters will look at the last 2 years tax returns – specifically the 1120 S form, which is the business tax return.
They will look at the gross sales and then look at line 21, which is the profit or (loss) that’s shown.
The gross sales are listed, then the expenses, salaries (if applicable) are backed out to get a bottom line profit or loss.
If line 21, which shows the profit or loss, has increased over the last 2 years, the numbers are added together and divded by 24.
If the numbers have declined, the lower number is used.
Many self employed homeowners assume that they will qualify for the mortgage loan. They know their gross business sales and they’re making money.
Business is good.
They have plenty of cash and they’re not in debt.
However, when underwriting a mortgage loan, the gross sales isn’t the sole mortgage loan underwriting determiner.
As I mentioned, it’s after the expenses, etc. are backed out of the gross sales that the business profit or loss is calculated and it’s based on this figure (averaged over 2 years or the lower of the last 2 years) that the self employed borrower will qualify on.
So if you’re self employed, check line 21 of the 1120 S form for the profit or loss and look at it over the last 2 years.
If that number has increased, add the 2 numbers up and divide by 24.
This is the number that the mortgage underwriter will use to determine your income for the mortgage loan application.
Often times, after the expenses are backed out, the profit drops and many self employed people cannot qualify for a mortgage loan.