Buying a home is a major life decision, and one of the most important factors in determining if you're able to purchase a home is your income. 

If you're self-employed, figuring out how much income you earn can be tricky. But don't worry—we're here to help! 

In this blog post, we'll walk you through how to calculate your self-employment income for a mortgage. 

How Do I Calculate My Self-Employment Income?

If you're self-employed, you likely already know that calculating your income for mortgage purposes can be a little complicated. 

But luckily for you, we're here to break down the exact steps lenders will use to determine how much you can afford based on your income.

Step 1: Figure Out Your Average Annual Income

First, you'll need to figure out your average annual income. To do this, you add your past two years' earnings together and divide by two.

(Year 1 Earnings +  Year 2 Earnings) / 2 = Average Annual Income

To obtain these figures, most lenders usually use your last two tax returns. If you've only been self-employed for one year, your lender will have additional documentation requirements you'll need to provide so they can determine your income.

Step 2: Calculate Your Average Monthly Income

This next step is pretty straightforward. You'll need to calculate your average monthly income, which you do by taking your average annual income and dividing it by 12.

Average Annual Income / 12 = Average Monthly Income 

Step 3: Find Your Maximum Allowable Debt Per Month

Once you have your average monthly income, you'll need to find your maximum allowable debt per month.

To get this figure, lenders will use a standard debt-to-income ratio (DTI) and multiply it by your average monthly income. It will allow them to determine how much you can afford to pay (including your expenses and mortgage).

Many lenders like to use a  DTI of 36% or less. However, some are willing to go as high as 50%. To play it safe, we recommend calculating this using a 36% ratio unless you have a specific number from your lender. 

(Average Monthly Income x DTI) = Maximum Allowable Debt per Month

Step 4: Determine Your Maximum Mortgage Payment

Many people stop at the last step, but that number isn't an accurate representation of your mortgage payment—it's your total allowable debt which includes your monthly expenses. 

Now, it's time to take them back out to get a better picture of your actual allowable mortgage payment. To do this, you'll subtract your maximum allowable debt per month from your actual monthly expenses.

Debt per Month - Existing Expenses = Maximum Mortgage Payment

Example

Okay, now that you know the process for the calculation, let's run through an example. 

For this demonstration, we'll pretend the first year's earnings were $75,000, the second year's earnings were $100,000, and the current monthly expenses are $700. We'll also use a 36% DTI for our calculation.

Using these figures, you'll see that the maximum mortgage payment will be around $1,925.

While this calculation will get you a ballpark estimate, it's essential to keep in mind that these figures are subject to change. You should speak with a mortgage professional to get an accurate estimate of what you can afford.

How Will My Self-Employment Income Be Used in the Mortgage Approval Process?

One of the most important things that lenders will look at when considering your mortgage application is your income. Lenders want to know how much money you're bringing in and whether that income will continue.

Lenders either use your net (taxable) income or your gross income. Which one they choose to look at will depend on a number of factors, including the type of loan you're applying for and the lender's own underwriting guidelines.

Typically, they'll use the net income you reported on your tax returns since that gives them an idea of your income consistency over the years.

However, for self-employed individuals who like to take advantage of write-offs, this can be a major problem.

There are other methods of assessing your gross income, including looking at your bank statements, using financial statements from your business, and others, but that will depend on your lender and their guidelines.

If you can, reach out to your lender and ask which type of income they will use to qualify you for the loan. By knowing which method your lender is likely to use, you can be better prepared with the required documentation. 

This will help make the loan approval process go smoothly and increase your chances of getting approved for the loan.

What Documents Do I Need to Prove My Self-Employment Income?

When you're self-employed, you need to bring a few extra things to the table when applying for a mortgage. 

While these requirements may fluctuate depending on your lender and the type of loan you choose, here's what the majority of lenders will need from you:

• Tax Returns: You'll need two years' worth of tax returns to show your income. These will be one of the most important documents lenders will need to determine how much they're willing to lend you.
• Bank Statements: If your lender opts to use your gross income, you'll need 12 - 24 months' worth of bank statements (business or personal), so they can get an idea of the cash flow of your business. They'll be looking for consistent income and not a lot of fluctuation month to month.
• CPA Letter: You must obtain this letter from your accountant to prove that you own the business, that it is in good standing, and that you have been self-employed for at least two years.
• Business Questionnaire Form: Loan officers use this form to understand specific details about prospective homebuyers, the properties they're interested in, and the ability to repay their mortgages.
• Your Driver's License: This is just a formality, but you'll need to show that you're who you say you are.

Take the Guesswork Out of Income—Let Us Help You Find the Perfect Loan

Applying for a loan as a self-employed individual doesn't have to be complicated or stressful. There are a lot of factors that go into self-employment income calculations for mortgage approval. But don't worry—we can help take the guesswork out of it. 

At Modern Day Lending, we understand that every client is different. That's why we offer a variety of loan options to fit your unique needs.

Whether you're a first-time or experienced borrower, we will simplify the process and help you find the best loan for your circumstances. 

Don't wait any longer—contact our team of experts today and let us get started!