Under FHA rules, self employed borrowers must provide 2 years of tax returns to demonstrate qualifying income. Bank statements cannot be used to prove income, but are required for qualifying assets. FHA requires just $100 in reserve after cash required to close (statutory down payment is now 3.50%; assets in excess of the minimum can be used as a compensating factor to offset higher debt ratios).
Tim Diersing's 1st answer below is solid - depreciation, depletion, and self-employment tax are examples of "add-backs" to determine qualifying income. I must clarify Tim's second answer somewhat... FHA does have specific debt ratio requirements, but if you have reserves in excess of the minimum, FHA's automated approval software may approve a higher front and back end debt ratio.
Front end debt ratio is the percentage of your qualifying income taken up by mortgage principal, interest, property taxes, and home owner incurance plus association fees if applicable. The ideal ratio cap is 28%.
Back end debt ratio is housing expense as above plus all other debts. The ideal cap is 43%.
I've seen back end ratios approved as high as 55% - but the front end was no higher than 28% - when the borrower had several months' worth of reserves.
Regarding amending tax returns... this topic comes up somewhat more frequently now on lender forums. FHA underwriters will require evidence the amended return has been filed (verified by a lender ordering a transcript of your returns using IRS Form 4506T) plus proof the additional tax obligation has been paid.
Do not amend your return without consulting a CPA first, then you must ensure that your prospective lender will accept the 1040X in place of the 1040 originally filed.
Depending upon what your tax records show you may still qualify for an FHA loan. Furthermore, there are certain items that can be added back to your bottom line for qualification purposes. I would talk to a reputable Mortgage Consultant prior to amending any returns. You may have conventional loan options as well. Based upon your question there are too many unknowns to offer any solid advice in this format.
Contact me. I'd be more than happy to take a look.
-Tim Diersing Fifth Third Bank 317.882.3206 or email@example.com
I am assuming you had a broker try to get you pre-approved? It seems that most folks need to have a 680 for an income waiver or verbal.
It may be quicker to try to raise you score a little bit. Go to http://www.optoutprescreen.com and do the electronic out for five years. This tends to raise scores (I have seen up to 20 points) in just a matter of two to three weeks. Also see if you have any credit cards that can be paid down to under 50% and if possible 30%. Many folks get stung with a high balance percentage on a $700 limit. This might help.
There is also a couple of investors left that will still take you bank statements (as long as it is just one).
Sounds like you have some options. Let me know if you need any help