Hello Kulishnekar and thanks for your question.
Most FHA lenders will look to your filed income taxes to verify income, and provided that you have filed taxes and have reported the income from the W-2s and your self-employed income (with 1099s) on a Schedule C - Business Income, the lender should not have any problems including both paid wages and self-employment income as "income" for the purposes of a loan. When income is verifiable through a third party (such as the IRS), the lender can be assured that the income was "documented" and not overstated. If the self-employment wages were never reported to the IRS or recognized on your tax returns, however, then there will not be any FHA lender willing to consider unreported income as "income" for the purposes of determining your mortgage.
If you wish to include your self-employment income, you will have to refile your taxes and include the self-employment wages as income. Keep in mind that there will be tax consequences for adding this income including interest on the balance due and employment taxes (FICA for self-employed). Also, it will take the IRS between 10-12 weeks to process and record your revised taxes, so your income will not be verifiable until the taxes are processed and available by the IRS. In the future, please remember that you must report all income earned from any source in excess of $600 per annum on your tax returns, which will help you if apply for any consumer loan.
Finally, you might want to talk with a qualified mortgage broker to see if there are other programs for which you might qualify. There may even be ways to bring your FICO score up just enough to qualify for a conventional loan under another loan that might involve less "hoop jumping."
If you have any additional questions, or should like personal references for mortgage brokers who might be able to help, you can email me or your real estate professional for more assistance.
Good luck and happy house hunting!!
Grace Morioka, SRES, e-Pro
Area Pro Realty