When completing income analysis for self employed borrowers there are a few key steps that must be followed.  A liquidity test must be performed before your borrower can use self employed income from a K-1 attached to a 1065 or 1120S tax form.  How to complete a liquidity test?  Follow these steps.

Step one

Make sure that the borrower’s business has stable sales and expenses that are generated for the borrower to earn income to in turn pay the new mortgage payment with. 

Step two

Validate the financial liquidity for the business.  In other words, document that the business can in fact pay the borrower the profits earned. That last part seems like an oxymoron, because if a company is profitable, why would it not pay its owners?

Let’s consider that statement for all borrowers, if a person works how would it be possible for them to pay a bill late, get a car repossessed, or file bankruptcy? The answer is just because you have some income (whether that is $50,000 per year or $500,000 per year) it is possible to overextend your finances and create financial havoc.

This same rule applies for business, they can generate income, but are they properly managing their expenses and savings to make sure that they have “liquidity” to pay not only employees and vendors, but the owners (your borrowers)!  After all that is where the money is coming from to pay the mortgage you are working on getting them. 

In the video attached to this blog we go over the guidelines for both Fannie Mae and Freddie Mac explaining what is required and why it is required.  We also show you what the guidelines do NOT, which is HOW to complete these liquidity test!

Guidelines to reference from the video in todays training!