Introduction
Let’s dive into how we look at the financials of a corporation when someone who owns their own business is trying to get a mortgage.
Overview
Business owners who run a corporation report their taxes using IRS Form 1120. For more on what a corporation is, check another section called “Business Structures.”
Corporate Fiscal Year
Sometimes, a business doesn’t follow the regular January to December calendar year for its finances. When this happens, and the business owner wants to use their income to get a mortgage, the lender needs to adjust the business’s financial information so it matches up with the owner’s personal tax returns, which are based on the calendar year.
Determining the Corporation’s Financial Position
After figuring out how much money from the business can be considered for a mortgage, the lender has to look at the overall health of the business. They can only use the business’s ordinary income (regular income from its activities) for the mortgage if:
– The income is steady and doesn’t change too much.
– The business is making more money over time, not less.
– The business has enough cash or assets that can be quickly turned into cash, so taking money out of it won’t cause problems.
Borrower’s Share of Income or Loss
When analyzing the money a business makes, the lender only looks at the portion that belongs to the borrower. They also adjust this income based on certain factors. It’s important to note that the income can only be used if the borrower owns the entire business.
Adjustments to Cash Flow
There are certain things that can be added back into the business’s cash flow when assessing it for a mortgage. These include:
– Depreciation (the decrease in value of the business’s assets over time)
– Depletion (the using up of natural resources by the business)
– Amortization (gradually paying off debt)
– Casualty losses (losses from sudden events like accidents or natural disasters)
– Net operating losses (when a business’s expenses exceed its income)
– Other special deductions that don’t happen regularly
However, there are also items that need to be taken out of the business’s cash flow:
– Expenses for travel and meals that aren’t included in taxes
– The business’s tax liability and any dividends (money paid to shareholders)
– Any debts the business has to pay within a year, unless there’s proof these debts are renewed regularly or the business has enough cash to cover them without issue
Recent Related Announcements
The table below lists recent updates related to how we look at a corporation’s financials for mortgage purposes, with the most recent update being on June 05, 2019, under Announcement SEL-2019-05.
References
For more details, visit Analyzing Returns for a Corporation of the Fannie Mae Selling Guide.