Evaluating the income of self-employed mortgage applicants presents unique challenges. Unlike W-2 wage earners, self-employed borrowers report lower taxable income due to various business deductions that don’t reflect their actual cash flow. Lenders use “add-backs”—adjustments for non-cash or non-recurring expenses like depreciation or amortization—to increase qualifying income. However, identifying these add-backs can be complex, time-consuming, and error-prone.
This article outlines common add-backs lenders should look for and highlights how tools like Baleen Lending can help simplify the process.
Key Add-Backs for Self-Employed Borrowers
When analyzing tax returns, lenders can restore income lost to various deductions, giving a more accurate assessment of financial capacity. Here are some key add-backs for both sole proprietorship and business owners:
Mortgage Notes and Loan Payments: Payments on business loans may be rolling over, meaning they don’t represent ongoing obligations. Adding these back can improve qualifying income.
Depreciation: This non-cash expense reflects the wear and tear of assets. Depreciation deductions on Schedule C or business tax forms like 1120S can be added back to boost income.
Amortization: Similar to depreciation but for intangible assets, amortization is another non-cash expense that doesn’t affect cash flow and can be added back.
Casualty and Other Losses: Non-recurring events like natural disasters can create large, one-time deductions that shouldn’t reduce qualifying income. Adding these losses back ensures an accurate assessment.
Home Office Deduction: Sole proprietors can deduct home office expenses. Since these are personal expenses, lenders can add them back to increase qualifying income.
The Challenges of Identifying Add-Backs
While these add-backs are crucial for boosting self-employed borrowers’ qualifying income, the process is often slow and complex. Here are a few common obstacles:
Manual Transcription: Tax returns, especially for self-employed individuals, are lengthy and require careful transcription into loan systems. Manually extracting relevant data not only increases the risk of errors but also takes a significant amount of time.
Specialized Knowledge: Properly identifying add-backs requires expertise underwriting guidelines, which can make it difficult to delegate these tasks to less experienced staff earlier in the pre-qualification process. This often results in bottlenecks and slower loan processing times.
Time-Consuming Process: Reviewing multiple years of tax returns and recalculating qualifying income based on business deductions can significantly slow down the underwriting process compared to wage earners. This extra time can delay approvals and put self-employed borrowers at a disadvantage.
How Baleen Lending Simplifies the Process
The good news is that tools like Baleen Lending can help lenders overcome these challenges. Baleen Lending automates the extraction of tax data, significantly reducing the time and complexity involved in analyzing self-employed income.
By scanning tax returns and automatically identifying relevant add-backs —such as depreciation, amortization, and casualty losses— Baleen Lending reduces the need for manual transcription and specialized knowledge. It integrates seamlessly with Fannie Mae’s Income Calculator, making it faster and easier for everyone from junior loan officers to senior underwriters to evaluate self-employed income.
Through Baleen, lenders can serve self-employed borrowers more effectively and speed up the mortgage approval process, growing their market share while leveling the playing field between self-employed applicants and wage earners.
Contact us at media@baleensolutions.com