When banks and other lending institutions examine the credit worthiness of traditional borrowers, they generally rely on income information that is backed up by tax returns, W2 statements and similar documentation. But when those same lenders analyze the tax returns of a self-employed individual, they face additional challenges. The income for self-employed individuals is rarely as steady and reliable as that of traditional employees, and that can make it harder for banks to assess whether a particular borrower will have the funds necessary to repay the money.
Examine the tax returns of the self-employed borrower for at least the last three or four years. Look at the yearly income trend shown on those returns. A pattern of accelerating earnings for the self-employed individual or business owner is a good sign, while declining earnings and revenue over time can be a warning sign that the borrower will not be able to repay the loan. According to Mary Miller, director of product management for Mortgages at Zillow.com, the tax return is the most important document banks and mortgage lenders have when determining the credit worthiness of self-employed individuals.
Request copies of the backup documentation the self-employed individual used to prepare the tax returns. Self-employed individuals who do freelance work should receive a 1099 Form from each of their clients. These forms provide important verification lenders can use to make sure the income reported is accurate and complete.
Obtain copies of the borrower's business checking or savings account statements. All business owners should maintain a separate account solely for their businesses--this makes it much easier to keep personal and business receipts separate. Business statements also make it easier for self-employed individuals to document the amount of income they receive from their clients.
Review the business records of the self-employed individual on a month-by-month basis. It is not unusual for self-employed individuals to have income that fluctuates on a monthly or seasonal basis, but it is important that there is sufficient income coming in to make the monthly payment on the loan.
- tax forms image by Chad McDermott from Fotolia.com