Loan Officer Training - 10/29/2024 - Analyzing Self-Employed Borrower Income: Sole Proprietor

Self-employed borrowers bring unique opportunities—and challenges—for loan officers. In this value-packed episode of Loan Officer Training, we take an in-depth look at how to analyze income for borrowers who operate as sole proprietors. If you've ever been stumped by complex tax returns, wondered how to account for fluctuating earnings, or struggled to identify stable income trends for self-employed clients, this episode is for you.

Join us as we discuss strategies for accurately interpreting tax documents, assessing cash flow, and spotting red flags that could impact loan approvals. We’ll walk through real-life examples of profit and loss statements, Schedule C income, and other key forms you'll encounter with sole proprietors. By the end of this episode, you'll be equipped to navigate the nuances of self-employed borrower applications, empowering you to make informed lending decisions and boost your loan approval rates.

Whether you’re an experienced loan officer wanting to sharpen your skills or new to the field and eager to grow your expertise, you won’t want to miss this essential guide to analyzing self-employed borrower income. Gain the insights and confidence to help more clients, close more loans, and stand out as a trusted advisor in the mortgage industry.

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About The Mortgage Calculator:

The Mortgage Calculator is a licensed Mortgage Lender (NMLS #2377459) that specializes in using technology to enable borrowers to access Conventional, FHA, VA, and USDA Programs, as well as over 5,000 Non-QM mortgage loan programs using alternative income documentation! 

Using The Mortgage Calculator proprietary technology, borrowers can instantly price and quote thousands of mortgage loan programs in just a few clicks. The Mortgage Calculator technology also enables borrowers to instantly complete a full loan application and upload documents to our AI powered software to get qualified in just minutes!

Our team of over 350 licensed Mortgage Loan Originators can assist our customers with Conventional, FHA, VA and USDA mortgages as well as access thousands of mortgage programs using Alternative Income Documentation such as Bank Statement Mortgages, P&L Mortgages, Asset Based Mortgage Programs, No Ratio CDFI Loan Programs, DSCR Investor Mortgages, Commercial Mortgages, Fix and Flip Mortgages and thousands more!

Our Mortgage Loan Originators are trained to be loan consultants to guide borrowers throughout the entire loan process. A licensed Loan Officer is only a phone call or zoom meeting away and always available to assist borrowers throughout the loan application process all the way to closing. To apply for a mortgage please visit our Quick Mortgage Quote Page at https://themortgagecalculator.com/Mortgage/QuickQuote

The Mortgage Calculator is a registered DBA of Mortgage Calculator Company LLC. NMLS ID #2377459. Programs and rates are subject to change without notice. Mortgage Calculator Company LLC is licensed in the following states that require specific licensing disclosures: AZ (#1040352), CA CFL (60DBO-171188), GA Georgia Residential Mortgage Licensee (#2377459), IL MB.6761755 Illinois Department of Financial and Professional Regulation, Division of Banking, 100 West Randolph, 9th Floor, Chicago, IL 60601 1-888-473-4858. Not licensed or conducting business in New York.

Catch all the episodes of the Loan Officer Training Podcast at https://themortgagecalculator.com/Page/Loan-Officer-Training-Series-Podcast

Catch all the episodes of the Loan Officer Training Podcast at https://themortgagecalculator.com/Page/Loan-Officer-Training-Series-Podcast

Loan Officers for Unlimited Free Non-QM Leads & Trainings Join The Mortgage Calculator at https://themortgagecalculator.com/join

The Mortgage Calculator is a licensed Mortgage Lender (NMLS #2377459) that specializes in using technology to enable borrowers to access Conventional, FHA, VA, and USDA Programs, as well as thousands of Non-QM mortgage loan program variations using alternative income documentation! 

Using The Mortgage Calculator proprietary technology, borrowers can instantly price and quote thousands of mortgage loan programs in just a few clicks. The Mortgage Calculator technology also enables borrowers to instantly complete a full loan application and upload documents to our AI powered software to get qualified in just minutes!

Our team of licensed Mortgage Loan Originators can assist our customers with Conventional, FHA, VA and USDA mortgages as well as acces...

Transcript

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Restream recording Oct 29, 2024 • 04:03:42 PM 0:13

Uh, thank you for joining us for today's training. And today we're going to cover analyzing self employed borrower income. Um, I am breaking down this series into business structures, right? Because previously we've covered this topic. Um, You know, just basically, uh, going into, um, all the different structures in one presentation, but I think it's a lot simpler if we break it down into the business structure and the 1st 1, uh, that we're going to cover today is going to be the sole proprietor. This is the most basic of the business structure. This is for an unincorporated. Entity. So let's get right into it. Uh, sole proprietor. So what exactly is a sole proprietor? Well, a sole proprietor is an unincorporated business with only one owner. Now, please note that in a sole proprietorship, the owner has unlimited liability and is taxed at the individual rate. That means that the business itself does not pay any taxes, any earnings that are passed on to the individual via the Schedule C and the 1040. They're going to pay at the end based on their individual tax rate. Now, uh, to be a sole proprietor, uh, you will be considered obviously a self employed individual. If you have at least 25 percent or greater ownership interest in the business. Now with a sole proprietorship, by the nature of the structure, there's only going to be one owner. So you will be a hundred percent, a hundred percent owner of the business and, uh, basically no other considerations there, uh, regarding being self employed or not. Now for most self employed loans, Please note that a two year history of self employment is required. That's really important to note because there are exceptions, right? At the Mortgage Calculator, we love providing solutions. But the exceptions, whether it's a conventional loan or whether it's a non QM loan, obviously these exceptions need to be very well documented to be granted by underwriting. But the exception would be If a borrower is receiving the same or greater income in a similar field or position, or the borrower is in a similar occupation in which they had similar responsibilities. So the similar occupation would be, for example, they were an electrician and now they're a self employed electrician. They were a nurse, uh, via W 2. Now they're a nurse, uh, via 1099. Those would be examples of that. And the same for the first bullet point there, uh, where they're receiving the same or greater income in a similar field or position. Um, now, here is where we really break it down regarding the income. Now, please note that for a sole proprietor, the only place where the income is going to be reported if they're an actual sole proprietor and not a partnership or anything like that, is going to be on the Schedule C. Remember, the Schedule C would be found in their personal tax return, which is the 1040. The income is reported on the schedule. See the gross income. Then you're going to have expenses like car expenses, depreciation, meals, insurance, whatever expenses that they have. In some cases, they even have mileage. Right? And then those expenses will be itemized on the Schedule C, and then you're going to have a net income on the Schedule C, and that net income on the Schedule C will be transferred to the Schedule 1, numeral 1, Schedule 1, where you're going to see in Schedule 1, an income from royalties, uh, Schedule Cs, and, uh, and other Components and will be in one of the line items in Schedule 1 and then that net income from Schedule 1 will be transferred to page 1, line 8 of the 1040. Right? That's that's where you're going to go. So if you reverse engineer it and you see an income on line 8. Page one of the 10 40. Then next thing you gotta do is, okay, let me look for a schedule one. Let's see where the income streams are coming for this borrower. And then according to the schedule one, one of the entries should be for a Schedule C. So then you're gonna go into the 10 40 to make sure there's a Schedule C. that is included. And if not, then obviously you're going to reach out to your borrower and let them know you need all the pages of the 1040, every single page, even the blank pages, if they're numbered, uh, because borrowers tend to send only, uh, the first two pages of the, uh, Of the 1040 without the Schedule 1 and without the Schedule C, which you actually, you know, totally need now, depending on if your borrower is going, uh, is applying for a Freddie Mac loan where you're using LP, or if they're applying for a Fannie Mae loan, where you're using DU is if you're going to use Freddie Mac form 91, which is the income calculation worksheet for Freddie Mac. Or, uh, Fannie Mae, uh, form 10 84, which is the self-employed borrower income calculator for Fannie Mae. So both of those forms are self-employed, borrower income calculators that you can easily download in PDF for Excel format, and then you're gonna input. The information depending on if you have a one year findings or a two year findings in your automated underwriting or if it's non QM, because this is all applicable for non QM as well, if you're using a non QM full doc program where you are using either one year or two year income. Remember, we do get to choose a non QM if we want the one or two year findings in the agency loan. It's automated underwriting that decides if you're going to get a one or a two year finding. So that's what, you know, you got to be aware of that and calculate your income accordingly. Now, what I like to do if I haven't run my automated underwriting yet, uh, and it's obviously an automated underwriting agency loan. If we're talking conventional, uh, VA, USDA or FHA, all those require automated underwriting. yet. If it's a conventional loan where you, this is the only one where you really get a one or two year finding the other options all require two years. So if it's a conventional loan, either Freddie or Fannie, I'm going to set it up with the best case scenario income. So the current year to date, uh, or the current 2023 tax return is higher than the 2022 tax return, which means normally you would average them out, right? I will use the higher 2023. Set it up with the higher income amount and, um, this is mainly for DU because in LP, if the business is five years in existence or greater, you can automatically use the one you're finding for LP. But DU doesn't go on the five year rule. DU goes on if they like, if DU likes the loan and the risk factor. Usually a 700 or higher credit score. Definitely. In this scenario, you may definitely, you may get the one year finding on DU, even if it's less than five years in business. So I like to set it up with the higher income, the higher 2023 income, get that good DTI, run it through a U S and see if I get the one year income findings. If I do not get the one year income findings, then unfortunately I would have to redo my income and average it out to 2022 lower and 2023 higher because if it's the opposite, if the 2022 is higher and the 2023 is lower, then you have the declining income and then you cannot average the numbers. You cannot average a higher, uh, prior year 2022. with a lower current year 2023 because it's declining. So in that case, you use the worst case scenario, the 2023 income, which is a lower of the two years. Keep in mind, if you have variable income involved, no, this is not going to be the case with this, uh, 1099, uh, course agency borrower. But if you have variable income, which we'll cover in a different training, uh, it's, uh, the opposite, you know, uh, if it's the same scenario, if you have a lower current value. You cannot average the higher prior year to the, with the lower current year. So it's the same relationship when you have variable income, you have to make sure the current year is higher and that the income trend is the same or higher for the variable income, like overtime and bonuses. So getting back to, to today's lesson. So we've already covered, you're going to use either form 91 or 1084, there's not going to be much of a difference when you're calculating a schedule C, just that if you're going to turn in an income calculation worksheet with your file to submit to underwriting, and it's a Freddie Mac loan, you want to make sure you have it on the form 91. And if it's a Fannie Mae loan, you want to make sure you have it on the form 1084. Uh, because that's what the underwriter will be looking for. If you, if, if it's, uh, passed the first quarter of the year, right? So January, February, March. So now we're in April or moving forward. Uh, your borrower is going to need to provide a year to date profit and loss. If the tax return, if it's in the first quarter and you have the current tax return for the year, you know, like 2024 now in January, For example, of 2025, then you would not need the P& L because you're in the first quarter of the tax reporting year. And if you have that year's tax returns, you're good. But once you pass the first quarter, a year to date P& L signed by the borrower will be needed. The P& L does not have to be prepared by the accountant. It can be prepared by the borrower, but it does have to be signed and dated. Now, when you are completing, uh, the, uh, Form 91 or 1084, Um, please note that there are certain, um, non cash expenses that, uh, can be added back to the income to calculate the adjusted income because these are non cash expenses. These are like paper expenses. And these are, uh, depreciation, depletion, amortization, and business use of the home. Now, please note, um, depletion and amortization are very similar. You're usually not going to have both. That is basically a business startup expense. However, the accountant specifically needs to report it as, um, amortization, right? And, uh, not, uh, business startup. Expense. Alright, so, uh, please also note that, uh, expenses that need to be deducted double would be, uh, like, uh, the meals because meals is only a 50% reduction in the expenses. Uh, uh, it's 50% write off. So the other 50% they hit you forward in the income. And please also note last but not least. Recurring or non recurring income or loss. If it's a non recurring income, you're really not going to be able to use it. Uh, you're going to have to back it out. What would be a non recurring income? Non recurring income would be, for example, uh, capital, capital gains, right? You, uh, sold, the business sold some equipment. That's not really income from operations, but it is income. That's income. So if you see it on there and you ask the borrower for the accountant to provide a letter and the accountant says, Hey, that was income from the sale of company assets. And it's not a usual and customary thing that the business does. Then you'd have to back it out. Conversely, if you have a non recurring loss, like a paper loss, like what would be, for example, a carry forward loss, like Four years ago, they had a 200, 000 loss. And for whatever reason, the IRS is allowing them to carry this loss forward through multiple years. If you get a letter from the accountant stating that that's what that is, and what's the nature of the loss, then there's a good possibility that you can add that loss back to the income, because that's not a real operating loss from the current year. It's a, uh, basically a non recurring paper loss. So that's basically it here. Um, let me give it a minute to see if, uh, there are any questions here from anyone regarding, uh, what is a sole proprietor and how you analyze the income of a sole proprietor in documentation. I'll give it a sec, couple of seconds here. Okay. Well, I guess, uh, hopefully I covered the topic, uh, very well. Uh, please do remember you can always reach out to us, uh, for assistance for all your loan structure and quote structure assistance. Thank you very much, everyone. And if there is are no questions and our training is over for today, everybody have a great day.