My Father was self-employed and I worked for my father, not in a traditional manufacturing or storefront type business that comes to mind. We lived in an Agricultural area in Southern Idaho, if you are thinking “famous potatoes’ this is one and the same not Iowa and acres of corn. We owned 276 acres and farmed 160-190 acres of it. We had irrigation and ability to water our crops, unlike dry land farming where the crop is planted early in the spring and depends on the rainfall for growth. We used gravity flow irrigation all through my school years, we had ditches run at the high points of the land and would run water into the ditches and use siphon tubes to draw the water into furrows known as corrugates that ran 24 inches apart all through the crop. Each morning we would be on the ditch bank by 7:00 a.m. to distribute the water over the crop. Honestly, to a young boy it was not the most exciting thing but as a grown man I look back on it with endearment and my respect for my father as a businessman is immeasurable. Farmers get a bad rap, they are not normally respected for being great businessmen and often viewed differently than the business owner that sits behind a desk but make no mistake about it to survive they have to be shrewd and knowledgeable, they have to be SMART!
If a person is self-employed, they determine their own schedules and govern their own responsibilities. The appeal for this runs deep in America, but few actually have the grit and determination to be self-employed. I look back with fondness of being raised on our farm, it taught me great discipline. Those years of waking early to irrigate the crop, feed the cattle and pull weeds and my all time favorite, pick rock out of the fields! However to this day I wake up early before the sun rises and when I was working for a major company, being late was not in my vocabulary. The type of determination needed to succeed as a self employed person begins with this type of commitment but the challenges that go with being self-employed is often more difficult than working for someone. Anyone can apply for a mortgage but for the self-employed obtaining a mortgage is an additional challenge. As a self-employed person you must meet different requirements than a salaried person to qualify for a mortgage. The rules about how this works have been updated recently to take an even closer look at business income. Let’s review the rules for self-employed borrowers for the first time. There will be many borrowers impacted by the new rules to qualify for a mortgage loan.
The most important things a lender will review for a self-employed borrower to qualify for a mortgage loan are income and assets, this will determine how much monthly payments a borrower can afford and also where the down payment is coming from. When we were farming, my father tracked all of the expenses for a full year. I remember my Mother sitting at the table every couple of weeks and logging all receipts and expenses, maintaining all records to be used to file as a sole proprietor and file self-employed income on IRS Schedule C, my parents would meet once or twice a year with an accountant and have the accountant file their taxes. Self employed borrowers report income as sole proprietors or owners of entities like corporations, partnerships, or limited liability companies, (LLCs)
Salaried employees get to use their gross income for loan qualifying, its pretty simple to calculate this part. If a salaried employee is paid $1250.00 every week to get the gross simply multiply $1200 X 52 week = $62,400 annually and divide by 12 months = $5200 monthly.
Self employed borrowers, sole proprietors must qualify using their net income from Schedule C. In addition, lenders calculate a 24-month average of net income for sole proprietors as opposed to salaried employees requiring one year of income in some cases. If the most recent Schedule C has lower net income than the previous year, lenders will use worst-case income by calculating a 12-month average of the most recent year.
If a self-employed person conducts business via a corporation, partnership, or LLC, the IRS requires these entities to file separate sets of tax returns. If the self-employed own 25% or more of the entity, they will need to provide lenders with full tax returns of these entities as well as personal returns. Just like the Schedule C, lenders will average income for 24 months using the 2 years of filed business and personal tax returns and if the current year is lower than the previous year, the lender will average 12 months of the lower year.
Occasionally self-employed borrowers have considerable amount of money in their business and may want to use those funds for down payment. Before a self-employed borrower does this, check with the lender, some lenders allow this and some do not. If it is allowed the lender will more than likely require their tax preparer verify that the use of the business funds for a home purchase won’t have negative impact on the business. Remember, income is the best and closest guarantee a mortgage will be paid.
In February of this year 2016, Fannie Mae updated self-employment income guidelines for borrowers who own partnership and S corporations. The intention for these guidelines is to determine whether a company has the assets to support the withdrawal of earnings to pay the owners. The guidelines impose much stricter analysis on income and debt trends of the company they own. As an owner of an entity such as this, the income from this type of entity is shown on a form called Schedule K-1. This is part of the tax-filing and the figures on this form get carried over to the owner’s personal tax return as income. This income most often comes in two main forms, “ordinary business income” and “distributions”.
The new rules for self-employed borrowers that report ordinary business income and/or distributions now impose conditions on whether you can use either of these forms. A good example would be if distributions are greater than ordinary business income, then ordinary business income may be used to qualify, but if the distributions are less than ordinary business income or they do not exist, there are a many more guidelines to determine how the borrower would qualify. The guidelines are specific to the borrowers profile and will vary by lender. At Gustan Cho Associates, we can analyze the best way to determine if a self-employed person will qualify as a full or part owner of a corporation or a partnership and with a host of many types of loan programs and associations can guide the borrower where the borrowers best interest are at heart. The Larry Stepp Team at Gustan Cho Associates are available 7 days a week, holidays and weekends.
Larry Stepp 407-922-4755 LarryS.HomesNetwork@gmail.com