Quick answer

Lenders look for verifiable, stable income and a predictable ability to repay. For self-employed borrowers that means clear tax returns, current profit-and-loss (P&L) statements, consistent bank deposits, a solid credit profile, reasonable debt-to-income (DTI) ratios, and business longevity. Lenders also evaluate non-income factors such as loan-to-value (LTV), reserves, and any lender-specific overlays.

Why self-employed underwriting is different

Self-employment income is often variable, one-time, or mixed with business expenses that reduce reported taxable income. Underwriters must convert those tax numbers into a repeatable monthly income figure they trust. That creates extra documentation and scrutiny compared with W-2 wage earners. In my 15 years helping self-employed borrowers, the difference usually isn’t that approval is impossible — it’s that supporting documents must be clear, clean, and well‑organized.

Sources: IRS guidance on tax records and the CFPB on mortgage underwriting and documentation expectations (IRS: https://www.irs.gov; CFPB: https://www.consumerfinance.gov).

What documentation lenders usually require

  • Two years of signed personal federal tax returns (Form 1040) with all schedules. Lenders use these to identify adjusted gross income and line-item business losses or non‑recurring items. (IRS)
  • Two years of business tax returns (if the business files them separately).
  • Year-to-date profit-and-loss statement (P&L), often signed by the borrower and sometimes by a CPA.
  • Business and personal bank statements (often 2–12 months) to verify cash flow, deposits, and transfers.
  • 1099s, K-1s, or W-2s where applicable.
  • Business licenses, client contracts, and invoices for irregular or seasonal income.

Depending on the loan program, lenders may accept alternative documentation such as bank-statement-only loans (where monthly income is calculated from deposits) or stated-income programs for qualifying borrowers; those programs typically require higher rates and reserves.

How lenders calculate income for the self-employed

Lenders will commonly use one of these approaches:

  1. Tax-return-based income
  • The underwriter averages qualifying income from the last two years’ tax returns. They add back certain non-cash expenses (for example, depreciation) and may subtract one-time gains. They focus on adjusted gross income and business net profit lines.
  1. P&L and year-to-date verification
  • A current year-to-date P&L can be used to show recent trends. If the P&L shows growth or a return to prior levels after a down year, underwriters may weight it alongside the two-year tax average.
  1. Bank-statement analysis
  • Lenders may calculate income by averaging qualifying deposits over 12–24 months. They strip out transfer activity and business expenses if the loan program specifies. This is common for 1099 contractors and business owners with high non-cash deductions.
  1. K-1 and partnership income rules
  • If you receive K-1 income from a partnership or S-corp, underwriters usually average the K-1 distributions and add back certain items depending on the program.

Practical note: legitimate add‑backs (depreciation, amortization, nonrecurring business expenses) can increase qualifying income — but they must be documented and consistent with tax forms.

Credit profile, DTI, LTV and reserves

  • Credit score: Most conventional lenders prefer scores above 620; for best rates and program access, 700+ is more competitive. Mortgage insurers and government programs have specific cutoffs.
  • Debt-to-income (DTI): Underwriters use DTI to measure monthly obligations versus income. Conventional programs often accept DTIs up to ~45% with compensating factors; government programs may be more flexible. See more on how LTV affects approval in our guide on Understanding Loan-to-Value (LTV) and Its Role in Mortgage Approval: https://finhelp.io/glossary/understanding-loan-to-value-ltv-and-its-role-in-mortgage-approval/.
  • Loan-to-value (LTV): A lower LTV reduces risk and can offset weaker income documentation.
  • Cash reserves: Lenders like to see reserves (months of mortgage payments saved) — especially when income is volatile.

Business stability, time in business and industry risk

Lenders evaluate whether your business is likely to continue producing income. Typical thresholds:

  • Two years in the same line of business is a common benchmark for conventional programs.
  • Borrowers with less than two years might still qualify with compensating factors (strong credit, larger down payment, significant reserves) or through non‑standard programs.

Underwriters also watch industry risk (for example, startups in highly cyclical sectors) and whether revenue is contract‑based or recurring (subscription-style businesses score better).

Lender types and program differences

  • Conventional (Fannie/Freddie): Require two years of tax returns; guidelines depend on automated underwriting system (AUS) findings and lender overlays. Learn how lender overlays can change eligibility beyond AUS results: https://finhelp.io/glossary/how-lender-overlays-affect-mortgage-eligibility-beyond-aus-findings-real-estate-mortgage-loans/.
  • FHA/VA/USDA: Government programs accept some compensating factors and may have more flexible credit and DTI rules, but still require solid documentation.
  • Bank-statement / alternative-doc loans: Useful when tax returns understate cash flow due to high non‑cash deductions. These loans use bank deposits as the income basis but usually charge higher rates and need more reserves.

Common red flags underwriters look for

  • Large, unexplained deposits in personal accounts.
  • Business losses that persist without a plan or explanation.
  • Significant schedule C write-offs that reduce taxable income to near zero while lifestyle suggests otherwise.
  • Rapid or unexplained income decline year over year.

Practical tips to improve approval odds (from my practice)

  1. Organize documentation before applying. Put together signed tax returns, year-to-date P&Ls, business bank statements, and contracts. Clean documentation speeds underwriting.
  2. Reconcile bank deposits. Create a short spreadsheet that explains recurring deposits, transfers, and owner draws so underwriters can follow the cash flow trail.
  3. Work with a CPA for tax-year cleanup. If you can legitimately reclassify expenses or document nonrecurring deductions, a CPA can prepare an addendum or a balance-sheet summary lenders trust.
  4. Boost reserves and lower DTI. A larger down payment or stronger liquid reserves reduces lender concern about volatility.
  5. Consider program fit. If standard documentation paints a distorted income picture, ask lenders about bank‑statement programs or government options.

Real-world example

A freelance graphic designer had strong bank cash flow but reported low net profit after depreciation and one-time equipment purchases. By assembling two years of bank statements showing steady deposits, a year‑to‑date P&L that excluded atypical equipment purchases, and a CPA‑prepared explanation of add‑backs, we qualified her under a bank-statement program and later refinanced to a conventional loan once tax returns reflected normalized profits.

Checklist for borrowers (before you apply)

  • Two years signed federal tax returns (personal and business, if separate)
  • Year-to-date P&L and balance sheet (if available)
  • 2–12 months of business and personal bank statements
  • 1099s or K-1s as applicable
  • Business licenses and contracts
  • List and explanation of any large or irregular deposits
  • Proof of cash reserves (bank statements)

Common myths

  • “1099s alone are enough” — Not usually. Lenders typically want signed tax returns and supporting bank statements or P&Ls.
  • “Lower reported taxable income means lower mortgage payments automatically” — Lenders use specific income calculations; legitimate add‑backs may restore qualifying income.

When to get professional help

Engage a mortgage broker or loan officer experienced with self‑employed files early. A CPA who understands mortgage underwriting can prepare P&Ls and explain add‑backs. In my experience, early coordination between borrower, CPA, and loan officer reduces surprises and shortens underwriting time.

FAQs (short)

  • Can I get a mortgage if I just started a business? Possibly, but expect more scrutiny. Lenders generally prefer two years in business; alternatives exist but require stronger compensating factors.
  • Will my business debt count? Yes. Lenders include business liabilities when calculating DTI or when they influence monthly obligations.
  • Do lenders accept electronic tax transcripts? Most lenders require either signed tax returns or IRS tax transcripts in addition to other documentation; check your lender’s checklist.

Sources and further reading

Professional disclaimer: This article is educational and does not provide individualized tax, legal, or lending advice. For decisions affecting your finances, consult a licensed mortgage professional and a tax advisor or CPA familiar with self‑employment issues.