Introduction
When a person owns a business and wants to buy a home, the income they report to the IRS might not show the full picture of what they can actually use to pay for a mortgage. It’s crucial to look closely at the money the business makes and gives to the owner, ensuring the business can still run well after these payments. This process helps figure out how much money from the business the homeowner can consistently rely on to pay their mortgage.
Factors to Consider for a Self-Employed Borrower
A person is considered self-employed if they own 25% or more of a business. Before a loan is approved, the lender must look at:
– How stable the borrower’s income is,
– The business’s location and what it does,
– How much demand there is for what the business offers,
– How financially strong the business is, and
– If the business can keep making enough money for the borrower to afford their loan.
Length of Self-Employment
Lenders usually want to see a two-year history of income to feel confident it will continue. But, if someone has been self-employed for less than two years, they might still qualify if they’ve completed a full year of self-employment and their tax returns show it. Their background should also show they have experience in the same type of work or business. When looking at less than two years of self-employment, lenders need to carefully consider how much experience the borrower has and how much debt the business carries.
Verification of Income
To check a self-employed person’s income, lenders can ask for the last two years of tax returns, both personal and business ones, filed with the IRS. Sometimes, just getting an IRS transcript of these returns is enough. If a business has been around for at least five years and the borrower has owned a significant part of it for five years, then only one year of tax returns might be needed. Each business the borrower owns is looked at separately to decide how many years of tax returns are required. The lender must also do a cash flow analysis, using a specific form provided by Fannie Mae or another similar form, and keep a copy in the loan file. There are also rules about using other documents to prove how long the borrower has owned the business.
If a borrower’s personal tax returns show their income from self-employment has been increasing over the last two years, and they’ve been in the same business for five years, lenders might not need to see the business tax returns.
Analysis of Borrower’s Personal Income
Lenders must write down how they figure out the borrower’s personal income from their business. This analysis helps to understand how much stable income the borrower has. This step might not be needed if the borrower has other sources of income that are not from self-employment. The lender can use different tools or forms, including one from Fannie Mae, to do this analysis. There’s a chance for lenders to get some protection if they follow certain rules when calculating this income.
Analysis of Borrower’s Business Income
If the borrower’s self-employment income is important for getting the loan, and the lender can’t skip checking the business tax returns, a detailed analysis of the business income is needed. This analysis compares the business to others in the same industry to make sure the borrower’s business income is stable and likely to continue. Lenders can use various forms or tools for this analysis, aiming to understand the business’s financial trends and viability.
Use of Income Calculator
Lenders have the option to use the Income Calculator tool from Fannie Mae. This tool helps calculate self-employed borrowers’ qualifying income on a detailed and per-business basis. It gives a comprehensive report that includes analysis, liquidity, and specific messages for each business being reviewed. This report is helpful for both manual underwriting and automated systems.
Use of Business Assets
If a self-employed borrower wants to use their business assets for a down payment, closing costs, or financial reserves, the lender must make sure taking these funds out won’t harm the business. This might involve looking at more documents or information than is usually needed to check the business’s income, such as recent business asset statements or a current balance sheet.
Income Verification for Self-Employed Co-Borrowers
If a co-borrower’s income from self-employment isn’t needed to qualify for the loan, the lender doesn’t have to document or evaluate this income. However, any business debts that the borrower is personally responsible for must still be counted in their total monthly debt when figuring out if they can afford the loan.
Verbal Verification of Employment
For rules on verifying employment verbally, lenders are directed to a specific section of the guidelines.
References
For more details, visit Underwriting Factors and Documentation for a Self-Employed Borrower of the Fannie Mae Selling Guide.