FHA and the Self-employed - Part III

Self-employed borrowers come in different shades and sizes. If you are applying for a mortgage loan for your personal use, you need a better understanding of what the lender is concerned about and why. This post will guide you.

The legal structure of a business determines the way income or loss is reported to the IRS, the taxes that are paid, the ability of the business to accumulate capital, and the extent of the owner's liability. There are five principal business structures: Sole Proprietorships, Partnerships, Limited Liability Corporations, S Corporations, and Corporations.

Knowledge of the structure of a self-employed borrower's business will assist the lender in evaluating the stability of the business and the degree of the borrower's involvement. In analyzing a self-employed borrower's personal income, the lender should focus on earnings trends and the actual sources of the income, not just on the total amount of the income. The lender must confirm the stability and likelihood of continuance for each.

Federal income tax returns (both individual returns and business returns) for the past two years, with all applicable schedules attached. Instead of obtaining a copy of a self-employed borrower's applicable tax returns directly from the borrower, the lender may use IRS-issued transcripts of the borrower's individual and business federal income tax returns that were filed with the IRS for the most recent two years, provided the information is complete and legible and the transcripts include the information from all of the applicable schedules.

Post questions and I will post answers.

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…….

FHA and the Self-employed Borrower - Part I

I have received numerous calls from self-employed borrowers since I posted an entry a while ago. I have decided to revisit this issue but I want to break it down in parts so that it is clearly understood. With the elimination of Stated loans (unless you have 25% to put down), self-employed borrowers need the facts on how to proceed on a fully documented loan using FHA.

So, here's your first tidbit for my caller in Texas who called and said, "A lender here told me I need a solid 2 years of self-employment in order to qualify for a FHA loan. Is that true?"

My response: Often the answer is yes. However, per Fannie Mae:

A person who has a shorter history of self-employment -- 12 to 24 months -- may be considered for a FHA loan, 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.

However, every file is different and must be taken as a whole. There's more to the story which we will cover in tomorrow's post. Stay tuned.