Mortgage Rules for Self-Employed Workers

When applying for a mortgage, lenders will classify you as a wage earner employee or self-employed. Furthermore, if you also own a business, or a percentage of a business, you might be considered self-employed even though you are a W-2 wage earner. If this is you, here’s what you’ll need to know to complete a mortgage application.

To start with, here are the income classifications for lending:

Employee: Individuals are W-2 wage earners and receive a paycheck. From the paycheck, taxes are withheld.
Self-employed: This includes everything else — a sole proprietorship, any business entity where income is derived or lost (including all affiliated corporations), income derived from real estate and dividend income are all included in the self-employed bucket.

Where the Two Worlds Intersect

Bona fide employees who also have an ownership interest in the company can actually be considered self-employed. For example, if you’re a W-2 wage earner employee and you have an ownership interest in the company that employs you – and the interest is more than 25% of the business, this would earmark you as ‘self-employed’ for the purposes of completing a mortgage application. If you happen to be a W-2 wage earner, but you have a percentage of ownership in another business, you would be considered both an employee and self-employed.

Business Ownership & Getting a Home Loan

Your federal income tax returns are required for the purposes of documenting ability to repay in securing a new mortgage. On your tax returns, as a sole proprietor you file a Schedule C, and this income carries over to Schedule A. Most sole proprietors don’t have separate business entities, so corporate returns are not required as it is 100% ownership. However, things are different when you have an ownership interest in a company.

Schedule E identifies whether or not there is additional business income and/or that you are an owner in an additional business.
If an additional business is present on the return, the mortgage lender will require a K-1 to determine the amount of percentage of ownership.

Mortgage Tip: If you own 24% of a business, you are not considered self-employed for the purposes of the loan application, and the lender will not need to obtain the corporate income tax returns. However, if you own 25% or more of a business – whether it’s your current employer or another business entity, as identified on the K-1 – then, yes, you’ll need to provide additional income tax returns for the entity in addition to your personal tax returns for obtaining the mortgage.

Why All Income Examination Matters

An ability to repay analysis is required on all mortgage loans. Simply providing W-2s, pay stubs and personal tax returns is not enough if you have more than a 25% business ownership interest in another company. If you’re receiving additional income from another business, and that income is tied to your personal tax returns necessary for securing that mortgage, it becomes necessary for the lender to need the additional tax returns because it supports your income and subsequent ability to repay. Lenders are required to average your income in most cases during the past 24 months (including the business income) and that averaged income or loss will be used on the application in accordance with obtaining the new mortgage.

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A financial word to the wise for the self-employed: By virtue of having an ownership interest in a company, you don’t need to provide the additional tax returns if you are a small minority share owner.