Agency rules
Fannie Mae Self-Employed Income Rules
What the guideline actually says, versus what a loan officer tells you it says. These are two different things more often than they should be.
Most of what borrowers are told about self-employed rules is the lender's interpretation, not the guideline. Here is the guideline.
The 25% line
Own less than 25% of a business and you are generally treated as an employee of it. Own 25% or more and you are self-employed for underwriting purposes, which changes what documents are required.
That single threshold decides how hard your file is. It is worth knowing which side of it you sit on before anyone pulls credit.
The two-year rule, and the exception nobody uses
Two years of self-employment is the standard. But there is a documented exception: one year can be acceptable where the borrower has prior experience in the same line of work, the income is stable or increasing, and the file is otherwise strong.
The reason you rarely hear about it is that many lenders add an overlay requiring two years regardless. The guideline permits one year; the institution's own rule does not. Those are different things, and a different lender may not have the overlay.
The add-backs
An underwriter starts with net profit and adds back what reduced it on paper without leaving the bank account:
- Depreciation — almost always the largest
- Depletion
- Amortisation and casualty losses
- Business use of home — you did not write a check for it
- Non-recurring expenses, with documentation that they will not repeat
- Meals, in part, since only a portion was deductible
The worked example is on how lenders calculate self-employed income.
Averaging, and the trap in it
If year two is higher, the two years are averaged. You do not get credit for the full increase.
If year two is lower, most underwriters use year two alone and ask why.
That asymmetry matters if you are planning around one strong year. Two consistent years beat one spectacular one.
Business income you cannot actually reach
If the business is a partnership or an S-corp, profit on a K-1 is not automatically usable. The underwriter asks whether the business can afford to distribute it, and whether it has a history of doing so. Retained earnings sat in the company are not your income for this purpose.
What this means practically
If your returns work after add-backs, conventional is the cheapest money on the table and you should be there. If they do not, the alternatives are on the self-employed page.
Send me two years of returns and I will tell you the real number, which is almost never the one on the bottom line.
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Questions people ask
Does Fannie Mae require two years of self-employment?
Two years is the standard. There is a documented exception at one year when the borrower has prior experience in the same line of work and the income is stable or rising, though many lenders overlay a stricter rule on top.
Is depreciation added back to self-employed income?
Yes. Depreciation reduced taxable profit without any cash leaving the business, so it is added back. It is usually the single largest add-back on a file.
What happens if my income declined year over year?
A declining trend is treated as the new reality rather than noise. Most underwriters will use the lower year alone instead of averaging, and will want an explanation for the decline.
Do I need business tax returns as well as personal?
It depends on ownership. Below 25% ownership you are usually treated as a wage earner. At 25% or more you are self-employed for underwriting and business returns generally come into it.
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