Thursday, March 20, 2008

Self Employed Income

Self-Employed borrowers -FHA considers a borrower owning 25% or more of a business as being self employed. If someone has 1099 income this does not make them self employed. However the documentation requirements are the same if more than 25% of the borrowers income is from commission income.

Why is this important to identify if someone is self employed or not if the documentation requirements are the same? When using the AU systems many times self employed status adds an extra layer of risk and you can loose an approval and get a refer.

FHA considers income from self-employed stable if they have been self employed for two or more years.
Between One and Two Years- an individual self-employed between one and two years must have at least two years of documented previous successful employment (or combination of one year of employment and formal education or training) in the line of work in which the borrower is self-employed or in a related occupation.
Less than one year-The income from a borrower self employed Less than one year may not be considered effective income.

The following documentation is needed for self employed borrower.

Two years Personal and business signed tax returns with all scheduled including W2's 1099's and K1's (Accept loans don't require Business tax returns if 1040's show increasing self employed income over the past two years, and funds to close are not coming form business accounts and the transaction is not a cash-out transaction)

A P&L is not required on a loan that gets an Accept. A P&L on Manuel underwrites is required. Refer require a P&L if

  • 7 months have elapsed since the business tax years ending date and income and
    Income to the self-employed borrower from each individual business is greater than 5% of his or her stable monthly income.

Analyzing Self employed income-The lender must establish the borrower's earnings trend over the previous two years but may average the income over three years, if all three years tax returns are provided. If the borrowers provides quarterly tax returns, the analysis can include income through the period covered by the tax fillings. If the borrower is not subject to quarterly tax fillings or does not file quarterly returns (form IrS 1040 ES), the income shown on the P&L statement maybe included in the analysis, provided the income stream based on the P&L statement is consistent with previous years earnings (I read this and have always said what would be the point than) If the P&L submitted for the current year show an income stream consistently greater than what is supported by the previous years tax returns, the analysis of income must be predicated solely on the income verified through the tax return..

Underwriters will have a problem with income that is declining from year to year. You would need to have a reasonable explanation for declining income and support that the income trend is no longer declining.