Introduction
This guideline provides important information for lenders when they are working with self-employed borrowers. It explains how to evaluate a borrower’s income and decide if it’s reliable enough for a mortgage loan.
Overview
When looking at self-employed borrowers, it’s key to understand that the income they report on their taxes might not always be cash they have on hand. For these borrowers, it’s crucial to look closely at how much money the business can pay them regularly. This involves checking the health and stability of the business to make sure it can support both itself and the borrower’s personal needs.
Factors to Consider for a Self-Employed Borrower
A person who owns 25% or more of a business is considered self-employed. When reviewing their loan application, several factors need to be examined:
– How stable the borrower’s income is.
– The type and location of the business.
– The demand for what the business is selling or the service it’s providing.
– How financially solid the business is.
– Whether the business can keep making enough money to help the borrower pay off their loan.
Length of Self-Employment
Lenders usually want to see a two-year work history to feel confident the income will keep coming. However, if someone has been self-employed for less than two years but can show a full year of self-employment income on their taxes, they might still qualify. They also need to show they’ve made similar money before, either in the same business area or in a job with similar duties.
In these cases, it’s important for the lender to really think about the borrower’s experience and how much debt the business has.
Verification of Income
To check a self-employed borrower’s income, lenders usually ask for two years of tax returns, both personal and business. They might also use tax return transcripts from the IRS. If the business has been around for five years and the borrower has had a big part in it for those five years, then only one year of tax returns might be needed.
For businesses, it’s also necessary to show they’ve been stable for five years. The lender will analyze the business’s cash flow to decide if the income stated in the application is accurate.
If the borrower has a strong record of self-employment income, the lender might not need business tax returns. This is more common when the borrower is using personal money for the down payment and closing costs, and their personal tax returns show their business income is increasing.
Analysis of Borrower’s Personal Income
The lender must write down their analysis of the borrower’s income to figure out how much of it is reliable. This includes looking at both the money the borrower makes and any losses. This step isn’t needed if the borrower has other income sources that aren’t from self-employment.
Lenders can use specific forms or tools to help with this analysis. If they follow certain steps, they might not have to double-check the income later.
Analysis of Borrower’s Business Income
If a borrower is counting on money from their business to get a loan, and certain conditions are met, the lender must also write down their analysis of the business’s income. They’ll compare the business to others in the same industry to make sure the income seems stable and likely to continue.
The lender will look at how the business’s income and expenses have changed over time to understand its health and future prospects. They can use different tools or forms to help with this analysis.
Use of Income Calculator
Lenders can use a tool called the Income Calculator to figure out a self-employed borrower’s monthly income. This tool looks at each business separately and gives a detailed report. It helps lenders understand the borrower’s financial situation better.
Use of Business Assets
If a borrower wants to use money from their business for the down payment, closing costs, or financial reserves, the lender must make sure this won’t hurt the business. They might need more documents than usual to see how the business spends and makes money.
Income Verification for Self-Employed Co-Borrowers
If there’s a co-borrower who is self-employed but their income isn’t needed for the loan, the lender doesn’t have to check their business income. However, any personal debt from the business must be considered when looking at the borrower’s total debt.
Verbal Verification of Employment
For more information on how to confirm a borrower’s employment verbally, see a different guideline.
Recent Related Announcements
Here are some updates related to this guideline:
– Announcement SEL-2023-11 on December 13, 2023
– Announcement SEL-2023-09 on October 04, 2023
– Announcement SEL-2022-10 on December 14, 2022
References
For more details, visit Underwriting Factors and Documentation for a Self-Employed Borrower of the Fannie Mae Selling Guide.