New Rules for Self-Employed Borrowers

Being self-employed requires a different set of credentials than a salaried person if you are looking to get a mortgage. Recently, the rules have changed for the population of self-employed borrowers, so let’s take a look at how this will impact you.

Self-employed borrower basics

The first two things lenders look at when deciding if you qualify for a mortgage is income and assets. This determines how much you can afford to pay per month. The income is reported as sole proprietor or owners of entities like corporations, partnerships, or limited liability companies.

As a sole proprietor, you are expected to file your self-employed income on IRS schedule C, which tracks your income and expenses for the year.

Apart from salaried borrowers who get to use their gross income for loan qualifying, a sole proprietor must qualify using their net income from schedule C.  A 24 month average of your net income is calculated for sole proprietors as opposed to the 12-month for salaried borrowers. If your income is lower than the previous year, lenders will use the 12-month average of the most recent year.

If you are self-employed and have a corporation, partnership, or LLC, the IRS forces you to file separate tax returns; and if you owe more than 25% on your entity, you will need to provide lenders with these full business tax returns, along with your personal.

Exactly like the schedule C, lenders average your income for 24 months using two years of business (and personal) returns, and if the most recent year is lower, they average your 12 month income.

As for assets, self-employed businesses have a lot of money in their businesses and use the funds for their down payment. Sometimes this is allowed, and if so, your tax preparer must verify that the funds in your business is being used for a home purchase, and it won’t have an impact on your business.

New rules

In February of 2016, Fannie Mae adjusted the self-employment income calculation guidelines for borrowers who own partnerships and corporations. They now use stricter guidelines on income and debt trends of a company to determine whether the company has enough assets to support the withdrawal of earnings to pay its owners.

If you own an entity like this, your income will be on a form known as a Schedule K-1. This document is a part of the entity’s tax filing, and the numbers carry over to your personal tax return as income.

This income often comes in two forms: “ordinary business income” and “distributions”.

The new rules for self-employed borrowers now contain conditions on whether you can use either of these forms of income. So if distributions are greater than ordinary business income, then ordinary business income can be used to qualify you. However, if the distributions are less than ordinary business income, then your qualification may be compromised.

All thes3e guidelines will be specific to your profile and they will vary be lender, so to be sure you qualify for a mortgage as a full or part owner of a corporation or partnership is to find a local smaller lender who can analyze your tax returns for you.

Confusing enough? I know right!

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