Editor’s note: The guidelines below apply to automated underwriting using FHA TOTAL Mortgage Scorecard. HUD offers a separate set of guidelines for manual underwriting.
Self-employed home buyers are eligible for FHA loans. But they have a few extra “hoops” to jump through, compared to borrowers who work for someone else.
Requirements and guidelines for self-employed FHA borrowers can be found in HUD Handbook 4000.1, also known as the Single Family Housing Policy Handbook. The self-employed income portions of the handbook took effect in September 2015 and will remain in effect for 2016.
Here’s an overview of the FHA self-employed income requirements for 2016:
Using Self-Employment Income to Qualify for an FHA Loan
Definition: Within the context of FHA loans, “self-employment income” refers to income produced by a business in which the borrower has an ownership interest of 25% or more.
According to the Department of Housing and Urban Development (HUD), which sets the guidelines for the FHA program, mortgage lenders can consider a borrower’s self-employment income if the borrower has been self-employed for a period of at least two years.
If the mortgage applicant’s self-employment period falls between one and two years, the lender “may only consider the income as Effective Income if the Borrower was previously employed in the same line of work in which the Borrower is self-employed or in a related occupation for at least two years.”
Stability of Self-Employment Income
To qualify for an FHA loan, self-employed borrowers must have a stable income stream from their businesses. The official handbook states that mortgagees (lenders) may accept income that is generated from businesses with “annual earnings that are stable or increasing.” In other words, the business cannot be in a state of serious decline.
If a self-employed borrower’s business income shows a greater than 20% decline in effective income over the period being analyzed, the lender must downgrade and manually underwrite the loan application file.
Self-employed FHA borrowers are required to submit additional documents when applying for a loan. These include business tax returns, profit and loss (P&L) statements, and balance sheets. Here’s what the FHA handbook says about these documentation requirements:
Individual and Business Tax Returns
When considering a self-employed borrower, mortgage lenders should obtain complete individual federal income tax returns for the most recent two years, along with all schedules. The lender must also request the borrower’s business tax returns for the last two years, unless the following criteria have been met:
- individual tax returns show increasing self-employment income during the past two years;
- the funds to close the loan are not coming from business accounts; and
- the FHA loan that’s being insured is not a cash-out refinance.
In lieu of signed tax returns, the mortgage lender may obtain one of the following documents:
- IRS Form 4506 (Request for Copy of Tax Return)
- IRS Form 4506-T (Request for Transcript of Tax Return)
- IRS Form 8821 (Tax Information Authorization)
- Tax transcripts directly from the IRS
Refer to IRS.gov for instructions on using these forms.
Profit & Loss Statements and Balance Sheets
In most cases, self-employed individuals seeking an FHA loan must provide a Profit and Loss (P&L) statement and a completed balance sheet for the business producing the self-employment income. Here is what the HUD handbook says about these document requirements:
The Mortgagee (mortgage lender) is required to obtain a year-to-date Profit and Loss (P&L) statement and balance sheet if “more than a calendar quarter has elapsed since date of most recent calendar or fiscal year-end tax return was filed by the Borrower.”
A balance sheet is not required for self-employed FHA borrowers who are filing Schedule C income. If the income used to qualify /approve the applicant exceeds the two-year average of tax returns, the Mortgagee must obtain an audited P&L or signed quarterly tax return from the Internal Revenue Service.
Calculating the Borrower’s “Effective Income”
Additionally, the lender must review the borrower’s tax returns in order to determine the gross Self-Employment Income. Specific requirements for analyzing the borrower’s self-employment documents can be found in Appendix 2.0 (“Analyzing IRS Forms”) of the Single Family Housing Policy Handbook. Mortgagees are required to calculate gross Self-Employment Income by using the lesser of:
- the average gross Self-Employment Income earned over the previous two years; or
- the average gross Self-Employment Income earned over the previous one year.
To learn more about HUD / FHA income requirements for self-employed borrowers, refer to:
4000.1: FHA Single Family Housing Policy Handbook
II. ORIGINATION THROUGH POST-CLOSING/ENDORSEMENT
A. TITLE II INSURED HOUSING PROGRAMS FORWARD MORTGAGES
4. Underwriting the Borrower Using the TOTAL Mortgage Scorecard (TOTAL)
c. Income Requirements (TOTAL)
Disclaimers: The self-employed income requirements for FHA loans shown above were adapted from HUD Handbook 4000.1, which is the official source for such guidelines. FHAhandbook.com is not an official source for FHA-related policy guidelines. We are independent publishers and are not affiliated with the Federal Housing Administration in any way. We make every effort to keep this website current. Despite these efforts, there is a chance this information may become outdated over time. For the most current and accurate information, please refer to the aforementioned handbook available at HUD.gov.