When analyzing income for a self-employed borrower, an underwriter should average income over which period?

When analyzing income for a self-employed borrower, averaging income over the past two years as reflected in the borrower's 1040 tax returns is the most appropriate approach. This method provides a comprehensive view of the borrower's financial situation.

Self-employed individuals may experience fluctuations in their income, so evaluating their average income over an extended period, such as two years, helps to smooth out these variations and offers a more stable and realistic representation of their true earning capability. The 1040 forms contain detailed information on income, deductions, and tax obligations, allowing underwriters to assess not only the income itself but also its consistency and reliability over time.

Relying solely on shorter periods, like recent pay stubs or W-2s, does not account for the unique income dynamics of self-employment, where income may not be received in a consistent paycheck format. Thus, using the average income reported on 1040s for the past two years gives a balanced and thorough understanding of the self-employed borrower's financial standing.