Owning a business and being “self employed” is an honor for myself and those of us who feel fortunate to be in control of our own destiny. As I wrote in Never a Dull Moment as a Small Business Owner being the captain of a small business is risky; some may consider it the most risky career path you can choose.
And now, if you are seeking a mortgage to buy a new home or refinance your existing property you face a whole new set of obstacles. Since Fannie Mae’s latest revision of its automated underwriting system (AUS) required documentation has more than doubled for self employed borrowers.
First, let’s define what a self employed borrower is for the purposes of mortgage underwriting. If you derive your income from a business or entity in which you own 25% or more, you are considered to be self employed. If you are a statutory employee you are self-employed. If you do not have taxes withheld or you have expenses on line 28 of the 1040: “Self-employed SEP, SIMPLE, and qualified plans” or on line 29: “Self-employed health insurance deduction” you will be considered self-employed.
Previous Version was a Walk in the Park
With Fannie Mae’s Desktop Underwriter (DU) version 8, only one year of a self employed individual’s personal federal (1040) tax return was all that was typically required. We would then take the gross income before adjustments but after deductible expenses and divide this by twelve for a monthly income number.
Now, with Fannie’s new version 9 which debuted late this past fall additional documentation will be required for self-employed borrowers. This includes personal (1040s) and business tax returns (1120, 1120s or 1065s) covering the most recent two-year period. Many times borrowers will include their state returns but they are not necessary; only the federal returns are required. And don’t forget to re-sign those signature pages. We are finding this is now a prior-to-closing requirement.
And even though the guides don’t ask the self-employed for a pay stub underwriters seem to ask for them.
Besides the actual tax returns with all schedules and statements any and all W-2s and 1099s are also typically necessary. And if you receive any income or (loss) from a K-1 on schedule E be prepared to provide copies of the tax returns of the entity providing the K-1s. The tax returns should include all K-1s. This is not typical but we were recently asked to supply this documentation for a borrower who derived a large percentage of one year’s income from these K-1 distributions.
Wait! We’re not finished, not yet.
At this time of year you probably haven’t yet filed your tax return for the previous year. You will therefor have to provide a profit and loss (income statement) for the previous calendar year. For instance, this is now February, 2013. You have produced and filed taxes for 2010 and 2011. More than likely, tax returns for 2012 have not been filed and this is the period for which an income statement will be required.
Hold on! There’s at least one more thing
A letter from your CPA stating that you have been self-employed for the last two years will be requested. Now, you’re thinking I disclosed that I was self employed on the 1003 application, I have two years of tax returns showing ownership, what more could they want. They want that letter or perhaps as an alternative copies of your business licenses from the last two years.
If you are a commissioned employee and derive 25% or more of your income from commissions then you also have an increased documentation requirement but not quite as big as the SE. You will be required to produce a recent pay stub with year-to-date info, W-2s, and personal tax returns covering the most recent two-year period. No business tax returns.
Here’s an anomaly: the DU Refi Plus, a program which many would consider riskier, has a reduced documentation requirement. If you are self-employed you will only be required to produce your personal tax return covering the most recent year.
One can never tell for sure after submitting this extensive documentation whether it will be sufficient. Your underwriter may see something that creates a question or concern. They may ask for additional clarification and typically reserve the right to do so in your conditional commitment letter. And don’t forget time frames are marching on. Suppose you don’t settle by April 15th… have your tax returns been filed? Then let’s see them. If not, you will be asked for copies of your extension.
It may seem like a complicated process and it can be unless you have the right person helping you navigate the self employed underwriting waters.