FHA Self Employed Borrowers

SELF-EMPLOYED BORROWERS

One of the questions that comes up is what is a self employed person / borrower.  A borrower with a 25 percent or greater ownership interest in a business is considered self-employed for mortgage loan underwriting purposes.  This would include people that are independant contractors, partners in a business or even persons that own S Corporations or Corporations.

Minimum Length of Self-Employment:  

The income from self-employment is considered stable if the borrower has been self employed for two or more years. Because there is a higher incidences of failure during the first few years of a new business FHA loans will require the following for individuals employed less than two years:
1) Between one and two years. An individual self-employed between one and two years must have at least two years previous successful employment (or a combination of one year of employment and formal education or training) in that or a related occupation to be eligible.
2) Less than one year. The income from borrower’s self-employed less than one year may not be considered as effective income and thus can not be used.

Underwriters will determine what makes sense to use for income.  One of the common mistakes that borrowers make is they assume that they get to count all of their self employment income.  Unfortuately, the only amount that gets counted is the Net Income or what is left over after expenses have been paid.

Documentation Requirements:

The following documentation is generally required:

1) Signed and dated individual tax returns, plus all applicable schedules, for the most recent two years.  Sometime lenders may want three years if the income fluctuates;
2) Signed copies of federal business income tax returns for the last two years, with all applicable schedules, if the business is a corporation, an "S" corporation, or a partnership;
3) A year to date profit-and-loss (P&L) statement and balance sheet;
4) A business credit report on corporations and "S" corporations.

Commission Income:

Commission income must be averaged over the previous two years. The borrower must provide his or her last two years tax returns along with a recent paystub. (Unreimbursed business expenses must be subtracted from gross income.) Commissions earned less than one year are not considered effective income.

Analyzing Income:

The underwriter will need to establish that the borrower's earnings trend over the previous two years. Annual earnings that are stable or increasing are acceptable. On the other hand, a borrower whose business shows a significant decline in income over the period analyzed may not be acceptable even if current income and debt ratios meet the guidelines. A very detailed letter of explanation will be required.  

This is part of the make sense equation.  Large swings in income will concern the underwriter as well as current earning that are less that the average or previous years.  If income fluctuates then this could be an issue as far as the stability of that income source.