Overview
When a person applies for a mortgage, the lender needs to figure out how much money the applicant really makes. This can get tricky because not all the money a person says they earn on their tax forms is guaranteed to keep coming in the future. To sort this out, the lender might need to look more closely at the tax documents provided.
This guideline explains how to handle different types of money a self-employed person might report on their tax form, IRS Form 1040, when the lender calculates their income for a mortgage.
It’s important to note that the rules for counting income from certain non-business sources are pretty much the same whether someone is self-employed or earns a salary from an employer.
Wages, Salary, and Tips
If a self-employed person reports wages, salary, or tips, it could mean two things. One, they might own a corporation and pay themselves a salary. Two, it might be income for their spouse who works for someone else.
If the spouse’s income is part of the mortgage application, it must be checked directly with their employer. This is because the spouse’s current income might be a better indicator of their ability to pay a mortgage than the past income reported on the tax form. Any income not used for the mortgage application should be taken out of the income calculation.
Interest and Dividend Income
Interest and dividends that a person earns and reports on their tax form can count as stable income if they’ve been receiving it for the last two years. However, this money can’t be counted if it’s being used for the down payment or closing costs of the house.
Any interest or dividends that won’t keep coming in should not be included in the income calculation.
If someone earns interest that’s not taxed, it can be counted as stable income if it’s expected to continue and has been received for the past two years. This kind of income should be added when calculating how much money the person makes.
State and Local Tax Refunds
Refunds, credits, or offsets for state and local taxes that a person gets should not be considered as income for a mortgage. This is because this money was already counted in last year’s taxes. The calculation for how much money the person makes needs to be adjusted by removing this income.
Alimony Received
Alimony can be counted as income for a mortgage if it follows certain rules. Any alimony that won’t continue should not be included in the income calculation.
IRA Distributions, Pensions and Annuities, and Social Security Benefits
Money received from IRAs, pensions, annuities, or Social Security can be considered as income. The rules for these types of income are detailed in another part of the guideline.
The part of this income that is not taxed should be added to the income calculation. If this income is tax-exempt, it can be increased in the calculation to show the benefit of not paying taxes on it. Income that will not continue should not be included.
Unemployment Compensation
Unemployment benefits can count as income if they follow certain guidelines. Any unemployment benefits that are not ongoing should not be included in the income calculation.
Other Income (or Loss)
If a self-employed person has other sources of income, the lender needs to check that this income is acceptable for a mortgage application. Any income that won’t continue or doesn’t meet the requirements should not be included in the income calculation. If there are any losses that won’t happen again, these can be added back to the income calculation.
References
For more details, visit Income Reported on IRS Form 1040 of the Fannie Mae Selling Guide.