If you're self-employed, your tax return and your mortgage application want opposite things. Your CPA is working to lower your taxable income. Your lender needs to see enough income to approve the loan.
On a recent episode of The Real Estate Returns, I sat down with Kristine Branon, a mortgage banker with Flat Branch Home Loans who has worked in lending since 2012. We covered how lenders actually look at your income, what trips borrowers up, and what to do when a conventional loan won't work. Here are the highlights.
Pre-Qualification vs. Pre-Approval
A pre-qualification is the first step. You fill out an application, the lender pulls your credit, and you get a letter that lets you shop and make offers. How deep a pre-qual goes depends on the loan officer. Some verify almost nothing. Kristine verifies income up front, because no one wants to go under contract and then find out they don't qualify.
A pre-approval goes further. The file runs through automated underwriting (Fannie Mae or Freddie Mac), and then a human underwriter reviews the actual documents: pay stubs, W-2s, tax returns, K-1s, and bank statements.
Small details matter here. Kristine shared a story about a borrower with good credit, a solid job, and healthy assets who was turned down by Fannie Mae for one reason: she was buying a manufactured home. Freddie Mac approved the same file.
Two more things to know:
Compare lenders using the loan estimate. It replaced the old good faith estimate and shows your rate and what it costs to get that rate. A lower rate often comes with higher fees.
Skip "buy now, pay later." Affirm, Klarna, and other financed purchases show up on your bank statements, and the lender counts those payments against your debt-to-income ratio.
How Lenders Calculate Self-Employed Income
The biggest misunderstanding is gross versus net. A borrower says they make $120,000, but that's their sales, not their bottom line. Lenders start with what you're actually taxed on.
From there, they make adjustments:
Depreciation is added back. It's a paper deduction, not cash leaving your account. That includes bonus depreciation on a vehicle or a rental.
Part of your business mileage is added back, but only if the miles are reported on the return. If the deduction is on page one of Schedule C and the mileage is blank on page two, the lender can't use it.
The nondeductible half of meals is subtracted. This one works against you.
Schedule C returns are usually the most straightforward. Partnerships and S corporations take more work. If a K-1 shows income but no distributions, the lender may question whether the business can actually pay you. A real balance sheet can show the cash is there and you chose to reinvest it.
One bright spot: if your business has been around for five years or more, you may only need one year of tax returns instead of two.
When the Income Won't Work
If you don't fit the conventional box, there are non-qualified mortgage (non-QM) options. Expect a higher rate and often a larger down payment.
Bank statement loans use 12 or 24 months of deposits instead of tax returns. The 24-month version usually gets a better rate.
1099 loans qualify you based on your 1099 income.
Asset depletion loans turn large retirement balances into qualifying income by spreading them over the loan term. These are available conventionally at age 62 and older, and as non-QM for younger borrowers.
For investors, the one to know is the DSCR (debt service coverage ratio) loan. It qualifies the property, not your personal income. The appraiser estimates market rent, the lender uses 75% of that rent to allow for vacancy, and then compares it to the mortgage payment.
Flat Branch will go as low as a 0.75 ratio, but the rate improves at 1.0 and again at 1.5. Short-term rentals can work too, though booking history and a strong location help.
Credit Still Matters
Your credit score affects both whether you're approved and the rate you get. Conventional loans no longer have a minimum credit score. Kristine has a borrower pre-approved with a 564 score because he's putting at least 20% down. Lenders also look at your payment habits, not just the number.
Talk to Your CPA and Lender Before You File
Kristine's best advice was simple: have the conversation early. Call your lender before you go under contract, not after. If you're self-employed and plan to buy next year, talk to your CPA before your return is filed. It's much easier to plan your taxes and your financing together than to amend a return or wait another year.
Watch or listen to the full conversation on The Real Estate Returns: YouTube, Apple Podcasts, or Spotify. If you're a real estate investor who wants your tax plan and your financing working together, learn more about Cornerstone CPA at rei.cpa.
This post is for education only and is not tax, legal, or lending advice.