Q&A

Q:

I am self-employed and want to buy a home. Apparently I am not claiming enough income to qualify for a loan. What can I do to fix this situation?

A:

Loans for self-employed persons can be more difficult than for a normal wage-earner. In your situation, the lender will require two full years of federal tax returns to document your income.

This is where the problem arises. The only income they will count is what is being claimed to the Internal Revenue Service (IRS) as your Adjusted Gross Income (AGI). As almost all self-employed persons claim every possible deduction from their income to reduce their income tax burden, the AGI is typically not representative of the true income for any given year.

There are items that are typically claimed as deductions that can be added back to the AGI such as any depreciation that was claimed against real property, any mortgage interest paid on real property, and any property taxes paid and claimed as a deduction.

However, often these adjustments are simply not enough to qualify for the loan amount desired. In this situation, the only way to remedy it is to claim more income for the following year. In this case, the lender will be required to average the past two years to establish what they can consider "effective income".

Another problem that can arise for self-employed persons is if they have claimed less income this year than they did in the previous year (after all adjustments as outlined above). If the income has declined from one year to the next, most lenders will be forced to deny the application due to declining income for a self-employed borrower.

So the best approach to take should you find yourself in this situation is to speak with a mortgage lender prior to filing the current year's income tax return. There are often minor adjustments that can be made that will save you heartache when you decide to buy.