Working for yourself can offer flexibility, independence, and the opportunity to build something of your own. If you’re thinking of buying a home using an FHA home loan, you may be wondering how your situation compares to your W-2 counterparts.
Being self-employed simply means your lender may take a different approach to documenting your income. Let’s take a look at what you need and what you need to know.
What Is an FHA Loan?
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD). The FHA doesn’t generally lend money directly to homebuyers. Instead, borrowers apply through FHA-approved mortgage lenders, while FHA insurance protects lenders against certain losses if a borrower defaults.
FHA loans are designed to expand access to homeownership and offer qualification guidelines that may work for a range of buyers. Depending on eligibility, borrowers may qualify with a down payment as low as 3.5%. FHA loans also have requirements related to factors such as credit, mortgage insurance, the property and the borrower’s ability to repay.
Self-Employed Borrowers Can Qualify for FHA Financing
As a self-employed borrower, your path may look a little different from that of a salaried employee, but the basic idea is simple: Your lender needs a clear picture of the income you earn through your business.
Instead of relying mainly on pay stubs and W-2s, you may be asked for documents such as:
- Personal and business tax returns
- Profit and loss statements
- Other records showing your business income
Types of Self-Employment
Under FHA guidelines, self-employment income is income generated by a business in which the borrower has a 25% or greater ownership interest. Self-employment can take several forms, and the documents a lender may request may vary depending on the business structure and other circumstances.
Business Owners
Business owners may operate a company independently or share ownership with other individuals or entities.
Freelancers and Contractors
Freelancers and independent contractors work for themselves and may earn income from one or multiple clients.
Sole Proprietors
Sole proprietors own and operate an unincorporated business themselves. They generally report business income and expenses on IRS Form Schedule C as part of their individual federal income tax returns.
Partnerships and Corporations
Partnerships are businesses owned by two or more people. Corporations are separate legal entities that may have one or multiple owners.
How Much Self-Employment History Do You Need?
Two years is a helpful benchmark to keep in mind. FHA guidelines generally call for a two-year history of self-employment when you’re using that income to qualify for a mortgage.
Haven’t been self-employed for two full years? You may still have options. Here’s what lenders may consider:
- Your previous work experience: If you’ve been self-employed for one to two years, a prior two-year history in the same or a related occupation may help support your application.
- Your income trend: Steady or increasing earnings can help show that your business income is likely to continue.
- Any recent changes: If your earnings have shifted, your lender may ask for additional documentation to better understand your current business performance.
Practical tip: Recently went from employee to self-employed in the same field? Hold onto records of your previous employment and experience. That history may provide helpful context when your lender reviews your income.
Documents You May Need for an FHA Loan
When you’re self-employed, there isn’t always a pay stub that neatly sums up what you earn. That’s why lenders may look at several financial documents to understand your income and business performance. What you’ll need depends on your situation, but these are some of the documents commonly requested:
Personal Tax Returns
Federal income tax returns help lenders review your income over time. They may also contain schedules showing income from a sole proprietorship, partnership, S corporation, or other source.
Business Tax Returns
Depending on your ownership interest and business structure, your lender may also request federal business tax returns. These provide additional insight into the company’s earnings and financial position.
Profit and Loss Statement
A year-to-date profit and loss (P&L) statement summarizes business revenue and expenses. Because tax returns reflect previous years, a current P&L can help show how the business is performing more recently.
Balance Sheet
When applicable, a lender may request a balance sheet showing the business’s assets, liabilities, and equity.
Tax Transcripts and Other Verification
Additional documentation, including tax transcripts, may be used to verify income information. Requirements vary, so check with your lender before ordering documents on your own.
Practical tip: Keep personal and business financial documents in separate, clearly labeled files. Having recent statements, tax returns, and financial reports easy to locate can save time when your lender asks for an updated document.
How Lenders Evaluate Self-Employment Income
Business revenue and qualifying mortgage income aren’t necessarily the same number. Lenders analyze financial records according to FHA guidelines to determine how much income can be considered for qualification.
Average Qualifying Income
Depending on the circumstances, lenders may calculate an average using documented self-employment earnings over an applicable period. This can provide a more complete view than relying on one especially strong month or quarter.
Business Expenses
Tax deductions can reduce taxable business income, which can also affect the income available for mortgage qualification. Lenders review the relevant tax forms and may make allowable adjustments under FHA guidelines when calculating qualifying income.
Recent Income Trends
Tax returns show your earnings from prior years. A lender may also review current business results and compare them with earlier periods to see whether your self-employment income has remained stable.
Income Stability
The lender needs to determine whether the income used to qualify meets FHA requirements and is reasonably likely to continue. Consistent, well-maintained financial records can help document the business’s earnings and support the lender’s review of income stability.
Financial Factors That May Require a Closer Look
Some financial details may prompt a lender to ask for additional documentation during underwriting. A few examples include:
- Recent changes in business income: If self-employment income has declined by more than 20% over the period being analyzed, FHA guidelines require additional analysis to determine whether the income can be used for qualification.
- Large business deductions: Tax deductions can reduce the net income reported on your tax return, which may affect the income available for mortgage qualification.
- Incomplete financial records: Missing or outdated documents may lead to requests for additional information before your income can be fully evaluated.
FHA guidelines are detailed in the HUD FHA Single Family Housing Policy Handbook 4000.1, which covers FHA requirements for lenders, including how self-employment income is documented and analyzed.
Preparing for an FHA Loan When You’re Self-Employed
Getting your paperwork organized early can make it easier to provide documents as your lender requests them. Before applying for an FHA loan, consider taking a few practical steps:
- Review your recent personal and business tax returns for completeness.
- Make sure your bookkeeping and financial statements are current.
- Gather recent profit and loss statements and other business records you already maintain.
- Keep documentation from previous employment if you recently became self-employed in the same or a related field.
- Be prepared to provide additional records if your income or business has changed recently.
It can be helpful to talk with a mortgage lender early in your home search. Your business structure, ownership percentage and income history can all affect which documents you’ll need. An early conversation can help you prepare the right records before you find a home.
Keeping your work history and financial records up to date can also help. You’ll be ready to provide the information your lender needs to evaluate your income in accordance with FHA guidelines.
