Written By: Joan Ewing, Op-Ed Writer
Hello- I hope everyone is getting ready for the volcanoes of refinances when the new guidelines are finalized. I am actually looking forward to being busy, busy, busy – I will begin to feel hopeful.
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Many processors and just as many underwriters that I know, start to panic, get heart palpitations and sweaty hands when they see a self-employed applicant. I cannot tell you how many processors have run into my office screaming for help – how do I qualify the borrower? I hope I can make your life a little easier by covering some steps for self-employment.
Important to remember - Any borrower who owns 25% or more of a business is considered self-employed for FHA mortgage loan underwriting.
Working for Relatives or Family Owned Business - Many times borrowers may say, I work for my father, my uncle owns the business, etc. Well that is fine – however, they must submit additional documentation to show they do not own a part of the business. In additional to paystubs and W2’s – they must also provide copies of their personal signed tax returns or a signed copy of the corporate tax return showing ownership percentages. The ownership percentage is located on the K-1 form.
What is the minimum length of employment of Self-Employment? If a borrower has been self-employed for two years or more – it is considered stable income. If an applicant is self-employed LESS than one year – the income may not be considered effective. Between ONE and TWO years – the income may be considered effective if the borrower has had at least two years documented successful employment or formal education in the field.
All self-employed borrowers must provide signed and dated individual tax returns, plus ALL applicable schedules for the most recent two years. If all schedules have not been filed – you cannot accept the income on page 1 for qualifying.
In addition – you need signed copies of federal business tax returns for the past two years with ALL applicable schedules, if the business is an “S” Corp or partnership. A year to date profit and loss statement and business credit report on corporations and “S” Corps.
OK – we have all the forms we need, let’s start analyzing the income. Two years is the magic number; however, the income may be averaged over three years. If the tax returns show an increase in earnings, use the two most recent years; however, if there is a decrease in earnings the income may not be used for qualifying. Let’s first look at the borrower’s Individual Tax Returns.
Wages, etc. Many times a borrower may pay him/herself a salary with a W2; in addition a spouse may also be working for the corporation and receiving a W2, in which case the income must be subtracted from the adjusted gross income in the analysis.
Schedule C – Business Income or Loss – The sole proprietorship income is calculated on Schedule C – and Depreciation and Depletion may be added back to the adjusted income.
Schedule E – Rents, Partnership Income – Any income received from rental properties may be used as income after adding back any depreciation – shown on Schedule E.
Schedule D – Capital Gain or Loss – Since most of the time this transaction generally occurs only once a year – it is not used for determining income. However, if the borrower is a housing developer or someone who buys and sells throughout the year, the income may be included in the income. The borrower would need to provide three years tax returns to show he has a history of Capital Gain income.
Schedule B – Interest and Dividend Income – This income which is taxable and tax-exempt, may be added back to the adjusted gross income only if it has been received for the past two years and is expected to continue.
Schedule F – Farm Income – Depreciation may be added to the adjusted gross income.
IRA Distribution, Pensions, Annuities and Social Security Benefits – Only the non-taxable portion of these incomes may be included and added to the adjusted gross income. Of course, you need to verify the income will continue for at least three years.
Employee Business Expenses – are expenses associated with the job the borrower is performing and must be deducted from the borrower’s adjusted gross income. When a borrower has a history of business expenses, you must also make an adjustment on the current YTD income by taking the percentage of last year’s expenses and deducting it from this year’s income.
Well – I hope this was not TMI (too much information) at one time. Next week, we will go over Corporate Tax returns.
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Until next week – keep processing. More later.
About The Author
Joan Ewing - As an op-ed writer and active FHA DE Underwriter for the past 15 years, Joan Ewing is a proud NAMP® Certified Ambassador Loan Processor (NAMP®-CALP). Joan brings years of FHA Government experience to her writings, letting her readers tap into her underwriting knowledge base.
