• Two or more years of self-employment are required (less than two years may be acceptable if the borrower has had at least two years' previous employment or a combination of one year's employment and formal education or training in a related occupation. Less than one year of self-employment is generally not acceptable.
• Borrowers are considered self-employed if they own 25% or more in a business (detailed information is provided later).
• A two-year minimum average income is needed to determine qualifying income. This is done to even out fluctuations common to self-employed borrowers.
• A positive overall economic outlook in the area for the particular type of business is considered.

 Self-employed borrowers are evaluated the same way salaried borrowers are-by determining if the borrower has sufficient income to support the mortgage payment and a willingness to repay all debt, evidenced by a credit report. However, the methods used in the analysis of the self-employed borrower's income are different.

In most cases, a salaried borrower's gross salary is used for qualification. This method is not adequate for the self-employed because the daily operation of the business must be supported by gross receipts along with income to the owner. This requires analyzing the borrower's federal tax returns and other schedules, depending on the type business, to determine net income to the borrower.

The growth, viability, and stability of the business field is also critical in determining the ability of the borrower to meet on-going obligations. The length of time self-employed and overall experience in the field must be considered.  Because of the subjective nature of underwriting these loans, it is important to put together a explanation along with documentation to support the income claim needed for the transaction.

Typically, borrowers who are receiving variable income which they wish to use as "qualifying income" must have their tax returns reviewed. This includes sole proprietors, borrowers owning 25% or more of a partnership, corporations or "S" corporations, LLC's, commissioned salespeople (even though they may receive W2's from their employer), and people who receive annual 1099's to substantiate their income.

The type of business the borrower has will determine the documents needed. Documents needed for different business structures are listed below.

• U.S. Federal 1040 with all applicable schedules attached
• Schedule C (Profit & Loss from Business)
• Schedule D (Capital Gains & Losses)
• Year-to-date Balance Sheet and Profit & Loss Statement

• U.S. Federal 1040 with all applicable schedules attached
• Schedule E, Part II (Income or Loss from Partnerships)
• Schedule K-1 1065 (Partner's Share of Income, Credits, Deductions, etc.)
• Form 1065 (U.S. Partnership Return of Income) with all applicable schedules attached
• Year-to-date Profit & Loss Statement
• Partnership Agreement 

• U.S. Federal 1040 with all applicable schedules attached
• Schedule E, Part II (Income or Loss from S Corporations)
• Schedule K-1 1120S (Shareholders' Share of Income, Credits, Deductions, etc.)
• Form 1120S (U.S. Income Tax Return for an S Corporation) with all applicable schedules attached
• Year-to-date Profit & Loss Statement
• Articles of Incorporation and documentation indicating the current owners and officers.

• U.S. Federal 1040 with all applicable schedules attached Form 1120 (U.S. Corporate Income Tax Return) with all applicable schedules attached Year-to-date Profit & Loss Statement.

A limited liability company (LLC) combines elements of a partnership, sole proprietorship, and a corporation.  For borrowing purposes these can include a Professional Association (PA), or Professional Limited Liability Company (PLLC).  

• Organizational documents and the Operating Agreement indicating  the current Members and Manager (if applicable)
• Depending upon the election taken with IRS (partnership or corporation), follow the same guidelines as noted above.

It's best to use at least two years, or three, of tax returns. This will stabilize the fluctuations in cash flow that may occur due to the normal ups and downs in many businesses. If an analysis of tax returns shows that the applicant has a pattern of reasonable increases in income each year, it makes sense to use the most recent year's tax return alone.

A reasonable increase would be in the range of 10 to 20% per year. An increase of 40 to 50% in one year over the past year is not a reasonable increase and may well represent some sort of windfall to the business that may not be maintained over the long term. A 24-month average would then be more logical to stabilize the income. Remember, common sense prevails in most of these decisions.