How Do Lenders Calculate Self-Employed Income?

The short answer

For most traditional loans, lenders take the net income from your last two years of tax returns, add back certain non-cash expenses like depreciation, and average the two years into a monthly figure. If this year is lower than last year, they may use the lower number. That monthly figure is what goes into your debt-to-income ratio.

The basic recipe

1. Start with net profit from your Schedule C, or your share of income from a partnership or S-corp (K-1s and, for some businesses, the business return).
2. Add back non-cash items such as depreciation, depletion and, often, business use of home.
3. Adjust for owner pay if you pay yourself W-2 wages from your own company.
4. Average two years and divide by 24 for a monthly number.
5. Check the trend. Steady or rising income is averaged. A drop gets a closer look.

Quick example (made-up numbers)

• Year 1 net profit $70,000 plus $6,000 depreciation = $76,000
• Year 2 net profit $80,000 plus $6,000 depreciation = $86,000
• Average: $81,000 a year, or $6,750 a month

If year 2 had fallen to $60,000 instead, many lenders would lean on the lower year or ask why.

What can trip people up

• A big drop in income without an explanation
• Large write-offs that shrink net income
• Business debts paid personally, or personal debts paid by the business
• Missing year-to-date numbers if it is late in the year

Frequently asked questions

Can a lender use just one year?

Sometimes, with a strong history in the same field and an underwriter's approval. It varies by program.

What if my taxes do not show enough?

Bank statement and P&L programs calculate income differently, usually at a higher cost. We compare all the routes.

See our self-employed mortgage guide, call (469) 414-5554, or visit our Texas branch.

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By Kelly Welton, Mortgage Broker (NMLS #314183), Mohave Mortgage Texas Branch. Mohave Mortgage NMLS #1830581 · Texas Branch NMLS #2690682 · Equal Housing Opportunity. General information only, not a commitment to lend or financial advice. Programs, rates and guidelines vary and change.