Loan Officer Training - 12/11/2024 - Verifying Business Ownership for Real Estate Loans

In this episode of Loan Officer Training, we tackle the critical process of verifying business ownership for real estate loans. Understanding the nuances of business documentation is key to ensuring smooth approvals and compliance. Learn how to identify the right documents, verify legitimacy, and effectively navigate complex ownership structures.

We’ll also share tips on how to streamline the process for your clients while maintaining accuracy and professionalism. Whether you're working with sole proprietors or complex partnerships, this episode will equip you with the knowledge to handle business verification like a pro.

Tune in and elevate your expertise! 🎧💼

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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! 

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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 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...

Transcript

Restream recording Dec 11, 2024 • 05:01:53 PM: 0:13

Self employed borrowers are a challenge as we all know. I'm trying to get their loans closed, but the challenges aren't just regarding the income of the borrower. The challenge is also in some cases, uh, documenting that the borrower is self employed. and documenting their percentage of ownership in the business to ensure that they qualify as a self employed borrower and to ensure that we are allocating their proportionate share of income to the income calculations. So those are the challenges we face and let's break it down to see how we can assist. Underwriting guidelines will always require verifying the borrower's ownership of a business, right, that they are actually self employed, and will also require that the percentage of ownership be clearly defined, uh, for all entities except a C corp, right, um, where, you know, a borrower is considered self employed typically if they own at least 25 percent Of the entity or greater unless it's a C Corp as you all know from our previous trainings on C Corp because a C Corp is an actual corporation. It's an entity that exists unto itself. Um, and the borrower owns shares in the C Corp, not the C Corp, and you can only attribute income or loss to that borrower from that corporation. If they own a hundred percent of the stock of the C Corp, so that is for C corporations only. So do understand the 25 percent rule does not necessarily apply to C Corp as far as business ownership. However, there are some guidelines QM world that may include C Corps in their definition. of 25 ownership equals self employed. So for non QM, you definitely have to review the guidelines for agency. I can pretty much guarantee that what we're stating here will hold true. C Corp, you have to own a hundred percent of the stock. Any other entity or business structure, 25 percent or more ownership in the entity or business. qualifies you as self employed. So what are the challenges that we face, um, in these types of situations? Well, one challenge is that there are no formal ownership documents, right? Um, it's a sole proprietor. He reports his income on a Schedule C. Uh, he's not incorporated. He doesn't have an LLC. He doesn't have a business license, no operating agreement, no articles of incorporation or articles of formation. He's just a self employed individual. Like for example, a handyman, right? How many handymen do you know that all they do is collect the money when they do the job, right? And then they put it in their bank account. And at the end of the year, they file their taxes. They don't have a business license to be a handyman. They don't have an operating agreement. They don't have an LLC, no, no S Corp, so that's definitely, uh, a challenge, right? But there are ways to verify business ownership, not just for this particular situation, but just in general, to verify their percentage of ownership and verify that they do own the entity. I'm going to expand on these in the following slides, but the ways to verify business ownership would be through a Schedule K 1. Is one way to do it through, um, articles of incorporation or articles of formation, depending on if it's an S Corp or if it's an LLC combined with an operating agreement, because the operating agreement is what lists their percentage of ownership and who are the members of the business and the amount of ownership that they have. And the third way would be a letter from the tax preparer. Or accountant or CPA, any of those three. Yeah, that's why we like to put CPA in, uh, quotes, quotation marks, because when we're talking about CPA and a lot of these scenarios, we don't mean an actual licensed CPA. That's just a word that they use to, uh, and it groups CPAs, accountants. And tax preparers in the group, uh, that can provide this third party verification for our borrower. Sorry about that. So, our first one there, first method is the Schedule K 1. Now, this is, the Schedule K 1 is provided to the borrower as part of either a 1065, Or an 1120 s. The, the 10 65 is the partnership tax return. Um, and the 1120 s is the S corporation tax return and the Schedule K one documents, uh, the distribution that the borrower received. Right. So that's one way. Yeah. If it's, but now this may be an issue for you to get a K one because if it's a loan. where tax returns are not being provided, then you definitely don't want to provide a K 1, because if you provide the K 1, they're probably going to ask you for the rest of the tax return to document the validity of the K 1. And that could blow your deal, right? Because then you're providing tax returns that document income, which if we're doing a bank statement loan, I can guarantee you that the income on the tax returns is not going to equal the income on the bank statement option, which is why we're doing the loan as a bank statement loan and not a full doc loan, right? Too many write offs probably. So, uh, please do know that in the K 1, box A as in Albert in part one will state the name of the entity or the business, right? So that's how you're going to know who Is issuing that K one to the borrower, the name, that's what we're trying to document here, right? We're trying to document that the borrower owns ABC corporation or ABC LLC. So box a, we'll let you know the entity name that's given them the K one. So that's how you're going to verify the business name and it's given to them to our borrower. So that's how you're going to verify that they're getting it. But most importantly, box G. In part two, we'll document what they call the current year allocation percentage, also known as their percentage of ownership in the business. So they own 35 percent in the business, it's going to state right there in box G, current year allocation is 35%. And, uh, that's how we document with a K 1. So like I mentioned, K 1 will be available if there's an S corp. that the borrower owns. K1 will also be available if the borrower, uh, has a partnership with somebody else to document, uh, their percentage of ownership and, uh, the name of the entity. So that's our first, uh, method. Second method is with the operating agreement. Obviously, the operating agreement combined with the Articles of Incorporation or the Articles of Formation or Organization. Articles of Formation or Articles of Organization typically are what they call the Articles for an LLC. And Articles of Incorporation is typically what they call the Articles for an S Corp. Um, now the Articles can verify self employment. But please note, very importantly here, the articles do not usually specify the percentage of ownership in the business. That will only be possible to accurately gauge through the operating agreement, right? Now, the operating agreement will specify the borrower's percentage of ownership in the business, whatever entity is that you have. Now, please note, A couple of additional points here to consider, uh, the operating agreement is not a publicly filed document. So it will need to be provided by the borrower. You cannot go to the secretary of state website and download an operating agreement for ABC LLC, for example, that's going to have to be provided by the borrower and do please make sure that it is signed and dated. Um, you will most likely be required to provide or the borrower will be required to provide an EIN letter from the IRS stating their tax ID number for the entity, and they will also need to provide a certificate of status, which then has a bunch of different names depending the state that it's in. Could be a Certificate of Good Standing, could be a Certificate of Existence. Uh, the good thing is that the document is usually easily accessed in the Secretary of State website for the state that the, uh, entity is organized or formed. Um, so do know, then do your search. If you do the search certificate of status for a particular state is going to tell you in Texas, it's called the certificate of existence, I think. And that document just confirms that the business is still active and in good standing as far as its filings. in the state. Now, please do know that if the operating agreement is less than two years old, right, the date on the agreement, the signature date, if the operating agreement is less than two years old, the guidelines may require additional verification, such as the letter from the CPA, uh, documenting when the business was formed. And actually a little bit more than that because that's our third and final method. for verifying business ownership. So if you do have an operating agreement, less than two years old, you're going to have to employ two documentation methods. One is the operating agreement. And then the other would be the CPA letter, unless you want to provide just a CPA letter from the get go. Uh, it is the best way to verify self employment when the borrower is not operating under an entity right now. It can be prepared, like I mentioned, by a tax preparer. accountant or CPA, and we'll need to provide a letter stating the buyers or borrowers percentage of ownership in the business, how long the borrower has owned the business, and also make sure that they mention if the business is still active. Please do note that this letter should be prepared and dated after the initial loan application date. The reason being because that letter refers you want to make sure it's not expired, but that letter can also be used as the verbal verification of employment for the self employed borrower, confirming that the business is still active. As you all know, before closing on a regular deal, not a, uh, on a non self employed borrower deal, you're usually going to have to do a verbal verification of employment anywhere from five to 10 days before the note date, the note date being the closing date. To make sure the borrower is still employed by the employer. Well, this letter of verification, the CPA letter, can be used to verify that the business is still active. So that letter, if the tax preparer includes verbiage in there that the business is still active, And the letter is dated, uh, after the application date, you should be good there because the verbal verification of employment for self employed borrowers usually calls for verification within the last 120 days that the business is still active. So do pay special attention to that condition and the number of days that they state you got to verify before the note date. And if your letter is, um, at or after that date, You know, if it's a letter 20 days ago, you're going to be good. But if the letter is five months ago and the condition says you got to verify this, uh, no more than 120 days from the note date, then that letter is not going to serve you its purpose. And you're going to need to get an updated letter with an updated date. So do note the sample letter that I have there, where it states the firm that represents the borrower. And that the bar is the owner of the company since the date that they own it and that they own a certain percentage of the company. It states the company's main business and if it has a website, the website address, and that the company is active, right? All the stuff that we need to know. Very important when using the CPA letter. is we have to verify the license. So you got to get their license or the license number. If they're a tax preparer, they're not going to have a license, but they are going to have an ID number that can be verified on various websites to verify that they are an active tax preparer. The CPA is going to have a license and the accountant may have a license or may have their tax preparer ID. So you do need to do that. Third, um, you know that independent verification of the, uh, tax preparer if you are, uh, providing a letter from the borrower. So, are there any questions? This is very important here. We are getting quite a few self-employed borrowers. You are gonna be asked for this kind of, um, information. So do keep this handy. So lemme give it a minute. See if we have any questions here on verifying self employment for borrowers. I must be doing a great job because we don't have any questions. Hopefully I did a great job explaining this scenario and hopefully you guys find this useful when searching for verification of your self employed borrowers. Okay, so we have no questions. So I do look forward to seeing you all tomorrow. Tomorrow's training. Thank you.