The guidelines are different for a self-employed person wanting to be approved for a mortgage refinancing loan. If you have at least a 620 credit score, you can get a good loan at a good rate if you qualify.
Lenders will run your loan application as they would for a W2 wage earner through the Desktop Underwriter system (DU). This is the system that conforms to Fannie Mae guidelines. If the response is Approve/Eligible, the lender who is processing your loan knows that the loan can be sold to Fannie Mae after they fund your loan. The other system is known as the loan prospector system (LP) and conforms to Freddie Mac guidelines. Most loans go to Fannie Mae however there are some instances when a lender would run your loan through the LP system.
From an income standpoint, a self-employed person must document with the last 2 years of tax returns that his/her income is sufficient for repaying the loan. A self-employed person may have just one business entity or multiple businesses entities. For each business, the tax returns or K1s may be examined by underwriting. A sole proprietor business is shown on the personal tax return (form 1040) on schedule C, and income from any other businesses may be shown on the schedule E page 2. This may include pass through income from C-corps, S-Corps and partnerships. Income from a rental property is normally shown on the schedule E page 1.
It is sometimes necessary to analyze these business tax returns carefully for possible income which can be added back to what appears on the 1040. K1s are used for the numbers on the schedule E of the 1040. Included in the K1 number often are items such as depreciation and amortization deductions from the business return. These items reduced the income on the K1, and the pro-rata share can be added back to the number. Also, underwriters will look at other non-recurring expenses and non-recurring income to see if items should be added or subtracted to the K1 number showing.
In most cases, a self empoyed person must have been operating his/her business for at least 2 years, however there are some exceptions when they have been in the same industry before as a W2 employee and only have 1 year behind them being self employed. There are a few subprime lenders currently offering loans based on bank statement deposits. These are niche lenders and there are only a few available though the interest rates are higher than a traditional lender. These lenders understand that often business owners take substantial write offs on their taxes and this reduces the taxable income to a point where they no longer qualify for a traditional mortgage refinance. Thus instead of the 2 years tax returns, they will accept 24 months of business or personal bank statements. They will add up all the deposits and divide by 12 or 24 and this number will be used for the monthly income.
Other factors in qualifying as a self employed borrower are very much the same as a W2 wage earner. Sometimes reserves are required for each investment property owned up to 6 months in the bank for principal, interest, taxes, insurance and association (if any) Reserves are usually not required on a primary residence however. Finally, most mortgage lenders will want to see some type of business license for their business, or if not required, a CPA letter regarding the fact that the accountant has prepared the tax returns, and the business owner has owned and operated the business at the same location for the last 2 years. If the entity is a corporation or LLC, formation papers will also be requested along with an operating agreement showing who the business owners are and their percentage of ownership.