Mortgage Self-Employment Analysis

Self-employment income
normally needs a two-year history of receipt to be regarded as stable and
ongoing income. Less than two years is “sometimes” accepted.
 
In mortgage lending, an individual is considered self-employed if he/she owns more than 25% of a business.
Self-Employed income analysis requires a history of being self-employed to be use as stable ongoing income. This means
that usually a 24-month history is required as a rule. If an individual has only been self-employed for three months out of the current year, and they are applying for a loan, it is unlikely that this income will be usable income.This is because there is no history to determine that the company is viable; the income stream is stable, nor if it is likely to continue in the near
future. Self-employment income can be tedious in this respect.
 
Self Employed Facts Considered
Self-Employed Status
There are several factors considered, and I will try to sum up some of this because it could get lengthy. The underwriter must always look at the borrower’s past income
history, employment history, and self-employment history. If a borrower has been in the same line of work for many years and has just become self-employed
in another field of work during the past month, there is not a justification for approval of the loan. 



There must be some history and likelihood of continuation. If there is little experience in his new field of self-employment,
and there is no way to determine the income stream will continue, this may not be usable income.


In most instances in the first year of self-employment, so many write off everything as loss or expenses, so even though the income was there, the bottom line does not provide sufficient income to qualify. This presents a situation in which there is not a single thing the mortgage underwriter can do about this kind of income
situation.
When the automated underwriting system, (AUS) is utilized in the underwriting process of mortgage lending, there are times when the loan may be approved with less than
two years of self-employment. (Most of the agencies use the AUS, but not on every product or loan.) It will depend upon the strength of the loan, credit
scores, assets and the entire financial status. Usually it will take the 700 plus score, and a substantial amount of liquid assets to make a file acceptable
without a history. There have been approvals when the AUS only asked for the prior year personal tax returns. 



 Again, this is all dependent upon the entire file evaluation. There are times when two (2) years personal tax returns  and two (2) years business returns are required along with a year to date profit and loss statement with financials.
 
Self-Employment Categories
Sole Proprietorship:
A sole proprietor is one who files 1040- schedule C income; profit and loss from business. He does not file separate business returns only schedule C in personal tax returns. The gross income less expenses, depreciation, and depletion, if applicable is how the income is reviewed. Normally the past 24 months tax returns are required,
and again; this does depend upon the AUS findings. 



The underwriter has a couple of income analysis worksheet to use; cash flow analysis and comparative income analysis. In schedule C income calculation, it amounts to using the bottom line net income from business after expenses plus depreciation for the past twob years.
 
Partnership:
A partnership is an arrangement between two or more people who together have pooled their assets
and their abilities to from a business. They share the profits and losses. It can be a Limited Partnership or a General Partnership. 
 
General Partnership:
Each partner is liable for running the business, personally liable for the debts of the entire business, and is responsible for the actions of the other partners of the
business, unless it is specified in the partnership agreement. A General Partnership is dissolved upon death, withdrawal or insolvency of any partner
but the responsibility of the creditors exists even if the partnership is dissolved. The partnership assets are applied to the creditor’s obligations
first and then the individual partner’s assets are applied to the partner’s liabilities.
 
Limited Partnership:
A Limited Partnership operates differently than the General Partnership. Each partner is not typically responsible for running the business on a daily basis and they have
limited decision-making ability. There is usually one General Partner who and who is personally liable for the debts of the entire business. 



A Limited Partnership is not dissolved at any one partner’s death. These partnerships are
sometimes formed for tax shelters therefore the Schedule K-1 will show a loss
instead of a profit. These partners file the IRS 1065 with schedule K-1, which
flows over to their IRS 1040’s personal tax returns, and the loss or profit is
taken into consideration for calculating income.
 
“S” Corporation and Corporation
The difference between Corporation and the “S” Corporation
 
“S” Corporations pass gains and losses on to their shareholders, who are then taxed at the tax rates for individuals. The “S” Corporation uses the IRS from 1120S (U. S. Income Tax Return for an S Corporation and the Shareholder’s share of income, credits, deductions; (Schedule K-1) for filing federal income tax returns for the corporation.
The shareholder’s (partner in the S Corp) share of income (or loss) is carried over to the Supplemental Income and Loss (Schedule E to IRS From 1040, personal
tax returns).


Ordinary income from the “S” Corp may be used to qualify the borrower only if the borrower’s business has a history of receiving such distributions on a consistent basis,
if the income is stable and consistent, the earnings trends are positive, and the business has adequate liquidity to support the withdrawal of cash without a
negative effect to the business. To determine the ability of the Corporation to have this withdrawal, the history of distributions must be reviewed and the
financial and liquidity positions. 



Normally a 2-year history is analyzed. AUS (automated underwriting system) will determine if business returns are required
and the number of years along with the client’s personal 1040 returns.
 
Corporation:
A corporation is a state-chartered legal entity that exists separately and distinctly from the owners, who are called stockholders
or shareholders. It is the most flexible form of business operation for purposes of obtaining capital. A corporation can sue; be sued; hold, convey, or
receive property; enter into contracts under its own name; and does not dissolve when its ownership changes.


There are two types of corporations—publicly owned (widely held) corporations and privately owned
(closely held) corporations. Because more than 50% of the outstanding stock of a privately owned corporation is owned directly or indirectly by no more than
five people, the corporation has little or no access to public funds and must raise capital through institutional financing.



Although legal control of the corporation rests with its stockholders, they typically are not liable for the day-to-day operations of the business. Since they elect a board of directors to manage the corporation and delegate responsibility for the day-to-day operations to the directors and officers of the company, it is not necessary for their daily involvement.
The corporation’s board of directors or other entities that have a significant financial interest in the business determines the distribution of profits earned by the business.
However, the profits are usually filtered down to the owners in the form of dividends. Since a stockholder is not personally liable for the debts of the
corporation, losses are limited to his or her individual investment in the corporation’s stock. 



Corporations must report income and losses on IRS Form 1120 and pay taxes on the net income. The corporation distributes profits to
its shareholders in the form of dividends, which it reports on 1099 DIV and flows to IRS 1040 for owner.
 
Limited Liability Company (LLC)
Explanation and Documentation
This type of business is formed to offer the members-owners the tax effects of a partnership and the limited liability of a corporation. The members of the LLC (or their assigned managers) can sign contracts, sell assets, and make other business decisions. The LLC operating affidavits may set out specific divisions of power among the
member-owners (or managers). Although the owners generally have limited liability, there may be occasions they are required to personally guarantee some of the
loans that the LLC obtains. Profits from the operation of may be distributed to managers. 



The LLC report their profits or losses on the IRS 1065, Schedule K-1, however, the LLC pays no taxes on its income. Each member-owner pays the taxes
individually from the income reported on the Schedule K-1. In other words, the tax liability of a Limited Liability Company will flow over to the member’s IRS
1040 for tax purposes.
 
 Linda Todd


check out Where We Are Now later post. and How Much Can I Borrow
 

2 thoughts on “Mortgage Self-Employment Analysis

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  2. Thanks Yashika for stopping by and leaving a comment, I appreciate it. Hope you enjoyed the self-employment analysis article.

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