Buying a home in North Carolina when you work for yourself

Step 1: Pull your last two tax returns

Before you talk to a lender, get your last two years of signed federal returns with every schedule. If you own a corporation or partnership, get the business returns and K-1s too. These are your income, as far as a mortgage is concerned. Bank deposits and invoices don't replace them for the loans NCHFA works with.

Also find out whether your lender will have you sign IRS Form 4506-C. Fannie Mae requires it for every borrower whose income is used, and it lets the lender pull your transcripts straight from the IRS.

Step 2: Figure out which kind of self-employed you are

FHA, Fannie Mae and Freddie Mac all treat you as self-employed if you own 25% or more of a business. A sole proprietor filing Schedule C owns 100%. Which form you file changes what the lender reviews:

Own less than 25%? Freddie Mac lets the lender count K-1 income under either its self-employed or employed rules, with two years of K-1s.

Step 3: Count your years

Two years of self-employment is the norm. The exceptions are narrow:

• FHA: 1 to 2 years works if you worked at least 2 years before that in the same or a related field.
• Fannie Mae: under 2 years works if your latest signed returns show 12 full months from the current business, and you earned the same or more before in a similar line of work.
• Freddie Mac: the lender documents a combined 2 years in the same or a similar field, and your returns show at least 1 year of self-employment income.
• VA and USDA: your lender confirms the rules.

So a pipefitter who worked six years for a Charlotte contractor and went out on his own 15 months ago may qualify now. A teacher who quit last spring to start an Etsy shop usually has to wait.

Step 4: Work out the number the lender will use

Lenders start with net profit, add back certain non-cash expenses, then average. FHA uses the lower of your 2-year average or your most recent year. The add-backs FHA and Fannie Mae list for Schedule C are depreciation, depletion, business use of home, amortization and casualty losses.

Worked example 1: rising income (made-up numbers)

The Greensboro HVAC tech netted $61,000 two years ago and $67,000 last year, with $6,000 and $7,000 of depreciation on his van and tools. Adjusted income is $67,000 and $74,000. The 2-year average is $70,500, which is lower than last year, so an FHA lender uses $70,500, about $5,875 a month. That's under Guilford's $110,000 limit for a 1 to 2 person household on the $15,000 option.

Worked example 2: seasonal income (made-up numbers)

An Outer Banks charter captain runs trips from spring through fall and is off most of the winter. Fannie Mae normally bars a gap of more than one month in the last 12 months for borrowers with more than one job, but it makes an exception for seasonal work. What counts is the yearly net profit on his returns, not the months he's on the water. If his last two years netted $48,000 and $44,000 with no add-backs, income dropped, and the lender will want to understand why. FHA would use the lower year, $44,000, because it's below the 2-year average of $46,000.

Worked example 3: S corporation (made-up numbers)

The Fayetteville barbershop owner pays herself a $36,000 W-2 and shows $20,000 of K-1 income. Fannie Mae counts the K-1 income only if her distributions match it or the business has enough cash on hand. A current or quick ratio of 1 or more is "generally sufficient." If the shop's cash is thin, the lender may count the W-2 alone.

Step 5: Gather the rest of the file

• Year-to-date profit and loss: FHA needs a P&L and balance sheet once more than a calendar quarter has passed since your last tax year ended (no balance sheet for Schedule C filers). Fannie Mae may ask for one if you apply more than 120 days after year-end.
• Proof the business exists: Freddie Mac wants third-party verification within 120 days before closing, such as your state license or a CPA letter.
• Business credit report: FHA requires one for corporations and S corporations on manually underwritten loans.
• Separate accounts: FHA can skip business returns only when, among other things, your closing funds don't come from business accounts. Keep your down payment savings in a personal account.

Step 6: Match your file to North Carolina's programs

NCHFA's programs are open to any occupation. The requirements are the same for everyone:

• a 640 credit score (660 for a manufactured home)
• a debt-to-income ratio of 45% or less
• qualifying income up to $158,000 for the 3% option, or total family income under your county's limit for the $15,000 option
• an FHA, VA, USDA or conventional (HFA Preferred or HFA Advantage) first mortgage

Two cautions. First, the $15,000 option counts total family income, meaning all titleholders plus a spouse, so a working spouse's pay adds in. Second, bank-statement loans are usually non-QM loans that can't be paired with state down payment programs. If your returns show too little income, the 3% or $15,000 help may be out of reach on a bank-statement loan.

City programs in Charlotte, Raleigh, Durham, Greensboro and Concord also have no job requirement, but each has its own income cap.

Step 7: Time your application

Big write-offs lower your tax bill and your qualifying income at the same time. If you plan to buy next year, talk with your tax preparer and a lender before you file, so both know your goal. Once you have two years on paper, check your eligibility and a lender can tell you which program fits.

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