FHA and the Self-Employed Borrower - Part II

OK, as promised this post will follow-up on the topic of mortgage lending for self-employed borrowers. Let’s finish up by asking this question: Who is considered self-employed?

Answer: Any individual who has a 25% or greater ownership interest in a business is considered self-employed. A number of factors need to be considered in underwriting a self-employed borrower, some of which may be beyond the borrower's control (although they still have a significant effect on the borrower's business).

Lenders analyze many factors before approving self-employed borrowers:

As per the guidelines (let’s discuss a few of these):

1. Stability of the borrower's income. This is a no-brainer and these days looked at by underwriters very closely.
2. The location and nature of the borrower's business, the demand for the product or service offered by the business, the financial strength of the business, and the ability of the business to continue generating sufficient income to enable the borrower to make the payments on the requested mortgage.
   
   Let’s discuss this briefly. Occasionally I receive calls from out of state borrowers who have a successful business, say in New York, and now they wish to relocate to GA. This is a problem for an underwriter trying to assess risk on a mortgage loan. It will take several months if not years to build up a new clientele. And your success is not automatic. In the process your income is lower. This must be taken into consideration.

Another question I am often asked: Why a two year history for self-employment?

Here’s a small dose of reality: Because income from self-employment may be unpredictable and the business owner is often personally liable for the business debt, self-employed borrowers tend to default at a much higher rate than other borrowers. For this reason, lenders require a two-year history of the borrower's prior earnings as a means of demonstrating the likelihood that the income will continue to be received. As stated previously, a person who has a shorter history of self-employment -- 12 to 24 months -- may be considered, as long as the borrower's latest federal income tax returns reflect the receipt of such income for a 12-month period and he or she has a history of receiving income at the same (or a greater) level in a field that provides the same products or services as the current business or in an occupation in which the he or she had similar responsibilities to those undertaken in connection with the current business.

In the next post, we will analyze the self-employed borrower in more detail.

Until then…….