How to Calculate Self-Employed Income for Mortgage Loans

When you're self-employed and looking to secure a mortgage loan, the process of calculating your income can be a bit more complex than it is for salaried employees. Lenders need to ensure that you have a reliable and sufficient income to cover the mortgage payments. Here’s a detailed guide on how to calculate self-employed income for mortgage loans:

1. Understanding Self-Employed Income

Self-employed individuals typically fall into two categories:

• Sole Proprietors: Individuals who run their own businesses and report income on their personal tax returns.
• Business Owners: Those who own a corporation or partnership and may pay themselves a salary or draw profits from the business.

2. Key Documents Required

To calculate self-employed income, you’ll need to provide:

• Tax Returns: Lenders usually require two years of personal tax returns and possibly business tax returns.
• Profit and Loss Statement: An up-to-date statement showing your income and expenses.
• Bank Statements: Recent bank statements to confirm the flow of income and expenses.
• Balance Sheet: For business owners, a balance sheet can provide insight into the financial health of the business.

3. Calculating Gross Income

Gross income is the total income before any deductions or taxes. Here’s how you can calculate it:

For Sole Proprietors:

1. Start with Your Gross Receipts: Look at your tax returns and identify the total amount of income received from your business.
2. Subtract Business Expenses: Deduct allowable business expenses, such as rent, utilities, and supplies. This will give you the net income, which is often what lenders will use.
3. Add Back Non-Cash Expenses: Certain expenses like depreciation are non-cash. Add these back to your net income to get your gross income.

For Business Owners:

1. Determine Your Salary: If you pay yourself a salary, use this amount as part of your income calculation.
2. Include Dividends or Distributions: If you receive dividends or distributions from the business, add these to your income.
3. Adjust for Business Expenses: Similar to sole proprietors, adjust for any non-cash expenses.

4. Average Your Income

Since income can fluctuate, lenders often average your income over a period to get a more accurate picture. To do this:

• Calculate the Average Monthly Income: Add your income for the past two years and divide by 24 (months).
• Adjust for Seasonality: If your income varies seasonally, you might need to adjust the average to reflect your typical earnings throughout the year.

5. Consider Your Income Stability

Lenders also look at the stability of your income:

• Consistency: Regular income with minimal fluctuation is viewed favorably.
• Industry Trends: Lenders consider whether your industry is stable or prone to economic cycles.

6. Additional Considerations

• Credit Score: Your credit score plays a significant role in securing a mortgage. Ensure your credit history is in good shape.
• Debt-to-Income Ratio: Lenders will assess your debt-to-income ratio to ensure you’re not over-leveraged.

Example Calculation

Let’s walk through an example calculation for clarity:

Example: Jane Doe is a freelance graphic designer. Her gross receipts for the past year are $120,000. She has $30,000 in business expenses, including rent, utilities, and software.

1. Net Income: $120,000 - $30,000 = $90,000
2. Add Back Depreciation: $5,000 (non-cash expense)
3. Gross Income: $90,000 + $5,000 = $95,000

Average Monthly Income: $95,000 / 12 = $7,916.67

If Jane’s income fluctuates, she may need to provide additional documentation or adjust the average based on seasonal trends.

7. Working with a Mortgage Broker

Navigating self-employment income calculations can be challenging. A mortgage broker or financial advisor can help you compile the necessary documents, interpret your financials, and present your income in the best light to lenders.

Conclusion

Calculating self-employed income for a mortgage loan involves compiling and analyzing various financial documents to present a clear picture of your earnings. By accurately calculating and presenting your income, you can improve your chances of securing a mortgage.