Written By: Stacey Sprain
As with any lending product, self-employment is always a topic that involves a lot of questions and uncertainty. The following FAQs represent a lot of the most common questions that FHA receives about self-employed borrowers and how to calculate self-employment income. These FAQS were derived from a recent self-employment webinar hosted by HUD in June of 2012 so they are considered quite current. You will find an archived recording of the self-employed borrower webinar event as well as recordings and archives for other HUD webinars at http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/tal....
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Q: What does FHA consider self-employed?
• A borrower owning more than 25% of a business is considered self-employed. A 1099 employee that files a Schedule C is considered self-employed.
Q: Does FHA have a required form to calculate self-employment income?
• No, FHA does not have a required form to calculate self-employment income.
Q: What does FHA consider declining income and how should it be treated?
• FHA does not have a set percentage of declining income that we consider unacceptable. It is up to the discretion of the DE Underwriter to evaluate the business as a whole and determine why and how much the business income is declining. If net income is declining, but gross receipts are increasing, then further analysis is required to determine one-time expenses, etc. A letter from the CPA can be obtained for further analysis. Prudent underwriting should be used to determine if income is considered stable for qualifying.
Q: If a borrower`s income has declined from the previous year but is determined stable for qualification, should a 2 year average be used or only the more conservative 12 month average of the most recent year?
• If the recent tax year shows less income than the prior year and the DE Underwriter has determined income is still stable for qualification, then it would be appropriate to base the qualifying income on a 12 month average from the current year.
Q: Can Business Use of Home be added back to qualifying income for a Schedule C borrower?
• No, business use of home is not recognized by FHA and should not be added back to income for qualification.
Q: Do Meals & Entertainment expenses need to be deducted from qualifying income for FHA purposes?
• No, FHA does not require meals and entertainment to be deducted from income for any type of self-employed borrower.
Q: If the loan is for one borrower, but the tax returns are filed joint with a spouse, does the non-borrowing spouse’s income or loss need to be considered in qualifying?
• No, the non-borrowing spouse’s income or loss should not be considered in qualifying. This applies to both Community Property States and Non-Community Property States.
Q: How should a loss from part time self employment or 2106 Expenses be reflected on the loan application for qualification?
• The loss should be reduced from the total qualifying income, not reflected as a liability.
Q: Are there any circumstances in which a Mortgage/Note Payable in less than 1 year would not need to be reduced from the borrower’s income?
• There would be few exceptions to this rule. For example, if the note or mortgage was refinanced so that it would not become due within 1 year, it would be acceptable to exclude the debt with appropriate documentation.
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Q: Is it acceptable to use income for a self-employed borrower relocating?
• Scenarios like this should be handled on a case by case basis and prudent underwriting is required. Location, clientele base and reasonability of continuance are of concern when a borrower will be relocating. However, if it makes sense and all issues are addressed with supporting documentation, it would be possible to use the self-employed income for qualification.
Q: When are Profit and Loss Statements and Balance Sheets required for self- employed borrowers and when must they be fully audited?
• According to Mortgagee Letter 2012-03, a YTD P&L Statement and Balance Sheet are required for self-employed borrowers, regardless of business structure, when more than a quarter has elapsed since the most recent calendar or fiscal tax year. If the income used to qualify the borrower exceeds a two year average of the tax returns, fully audited P&L is required.
Q: If AUS findings do not ask for a P&L Statement and Balance Sheet, are they still required to be obtained?
• Yes, Per Mortgagee Letter 2012-03, a YTD P&L and Balance Sheet are required regardless of AUS approval. No more than 3 months can pass without income being verified with supporting documentation.
Q: If not using self-employed income do we still need a YTD P&L & balance sheet?
• Not typically. However, if there was a loss in the prior years on tax returns, the question should be asked about YTD and losses deducted from income.
Q: If a Self-Employed borrower has filed an extension for 2011, may income be calculated based on income from the 2010 and 2009 returns?
• As of April 14, 2012, the 2011 tax returns should have been filed. However, under certain circumstances where an extension has been filed, at the discretion of the DE Underwriter, P&L’s and balance statements for 2012 YTD must be provided to support qualifying income. If the income used to qualify the borrower exceeds a two year average of the tax returns, a fully audited P&L is required.
Q: If a borrower files a Schedule C due to 1099 earnings but is employed by a company, are the P&L and Balance Sheets required?
• Yes, any borrower filing a Schedule C (or other self employed business structure) would be required to provide these documents.
Q: Can debts paid by the business be excluded from qualifying ratios?
• If the business structure is a Schedule C/Sole Proprietor, then the debt cannot be excluded from ratios. For a Partnership, Corporation, or S-Corp, the debt can be excluded with 12 months cancelled checks or bank statements from the business, and there have been no late payments within the past 12 months. The debt should also be shown on the tax returns as an expense of the business and the business is the primary obligor.
Q: When is a business credit report required?
• Only on a manual underwrite for business structures other than sole proprietor/Schedule C.
Q: Why are corporate credit reports required when the individual is not liable for the corporate debts?
• On a manual underwrite, it is necessary to obtain a business credit report for business structures other than Sole Proprietorships in order to determine whether or not business debts are being paid on time and the likelihood of repayment of the mortgage. Major delinquencies are a sign that the business may be in trouble which impacts the stability of employment and qualifying income.
Q: What is the proper calculation for rental income using 2 years tax returns as required?
• To calculate rental income using the 1040 Schedule E, use the net income plus depreciation for both tax years and average the figures over 24 months. Using this calculation, you will not include the mortgage payment in the total debt as the debt is already reflected in the net income after expenses. *Note: If income has declined from previous year, take the same considerations as declining self-employed income to determine the stability for qualification. When using a lease is necessary to calculate rental income, use the gross monthly amount of the lease less the appropriate jurisdictional HOC vacancy factor and include the payment in the debt ratios.
Q: When calculating rental income from tax returns, does the vacancy factor still need to be applied?
• No, vacancy factor does not need to be applied when using tax returns. Vacancy factors only apply when using a lease agreement.
Q: Where are the current vacancy factors for each area listed?
• Go to http://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/ref...
Q: If a borrower has multiple properties on Schedule E where some have positive income and some have losses, can we take the net loss or profit and add to income or include in liabilities?
• No, the rental income or loss must be calculated individually for each property and reflected on the schedule of real estate.
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Q: Can rental income be considered on a current primary residence being vacated?
• It is generally not acceptable to qualify using rental income from a current primary residence being vacated, however, there are exceptions. See HUD Handbook 4155.1 4.E.4.h for the conditions under which using rental income in this scenario would be acceptable and the documentation required to do so. If the property will be rented to a family member, the same conditions apply and it is necessary to support the rental amount with evidence of market rent for the area. Additional requirements may apply based on the discretion of the DE underwriter.
Q: If an investment property has been owned less than 2 years but income is documented per the most recent year of tax returns, is it acceptable to use rental income for qualification?
• Yes, there is an exception for using rental income without having a 2 year history. If reflected on the most recent year of tax returns, the income should be calculated based on the Schedule E. If the property was purchased subsequent to filing the most recent year of tax returns, a lease may be used. In either case, prudent underwriter discretion should be used to determine the stability of income used for qualification.
Q: What is the appropriate calculation for Farming income?
• Farming income is based on the net income figure from 1040 Schedule F plus depreciation.
Q: If the subject property is also reported on Schedule F for farming income/loss, is it automatically considered an ineligible property type or working farm?
• Not necessarily. There are a few exceptions, such as a hobby farm which is not income producing. However, this scenario should be addressed on a case by case basis and checked with the appropriate HOC before approving a loan.
About The Author
Stacey Sprain - As an NAMP® staff writer, Ms. Stacey Sprain is currently a NAMP® member in good standing, and is a NAMP® Certified Ambassador Loan Processor (NAMP®-CALP). With over 15+ years of mortgage banking experience, Stacey is also a Quality Control Manager for a major mortgage lending institution. If you would like to become a volunteer writer for us, please email us at: contact@mortgageprocessor.org.
