During 2015 FNMA had notified users in a few of the SEL’s about guideline clarifications on self employed borrowers that felt a bit like a seesaw. As you remember there was a big change announced early in 2015 that dramatically shifted the way we calculated income for borrowers who are self-employed using a partnership, LLC, or small corporation (using business tax forms 1065 & 1120S). The change was centered around comparing boxes 1,2, and 3 of your K-1 to the actual distribution amount on the K-1 and required the seller to use the lessor of the two. This resulted in a few turned down loans that just weeks before would have been approved on the “older” method but now did not make the cut.
25% Rule Qualifies More Borrowers
Within a few months of this change going into effect FNMA published clarifications again in an SEL and did slightly back off distributions versus income move announced a few months back. These clarifications (FNMA stated they were not changes just clarifications) to the income calculations were also accompanied with a newly redesigned 1084 cash flow form (dated 08/25/15). The good news during all these announcements FNMA has provided some information which may help a few more borrowers qualify!
If a borrower has less than 25% ownership in a business, the borrower is NOT required to remove any losses reported on the K-1, which means more income. This information is found on FNMA “Top Lender Questions” , which says “ for borrowers with business income reported on schedule K-1 and who own less than 25% of the business, the lender is not required to consider business loss in the evaluation of income” (Read B3-3.1-09).
Hopefully this “little” change could help a few more people to qualify for a mortgage. Over the years I have had to turn down a few applicants due to losses reported on schedule K-1’s for this exact scenario.
6 Responses
Michael, thank you for this information. I have been searching FNMA Selling Guide and even called them to find out where to locate the information regarding disregarding losses when <25% ownership. If you have this document would you please forward it to me?
Please clarify where this can be found on Fannie Mae’s website.
Good Morning Sam
The blog you posted on was published January 2016, the guidelines have since changed. At the moment the only thing similar that FNMA comments on that I am aware of is found in FNMA B3-3.2-01 which states ” Income Verification for Self-Employed Co-Borrowers
When co-borrower income that is derived from self-employment is not being used for qualifying purposes, the lender is not required to document or evaluate the co-borrower’s self-employment income (or loss). Any business debt on which the borrower is personally obligated must be included in the total monthly obligations when calculating the debt-to-income ratio.”
Thank you for the question!
Michael
How would this apply to a borrower with less than 25% ownership who is receiving guaranteed payments from the same entity? Some say you would need to consider losses if they are reported on the same k-1 as guaranteed payments and others say ignore the losses and use guaranteed payments.
Hi Jay
There is no clear answer on it… but I would defualt to adding up lines 1,2,3 and 4C (guaranteed payments)… that would be the more conserative method. Using the full Guaranteed payments without reducing the loss on lines 1,2,3 does not seem right but I don’t have a guideline I can point too.
Hi, do you know the current guideline for this for the 25% rule?