There’s a totally different way we qualify self-employed borrowers versus wage earners that are employees that have less than 20% ownership in a company. A self-employed borrowers, they can be different types of entities, they can have a Subchapter S Corporation, they can be an LLC, they could be a sole proprietorship, all of those are going to fall under the classification of self-employed borrower. How we calculate that income versus how we calculate somebody that is an employee is where the trouble comes in.
Generally for self-employed borrowers you need two years of self-employed history. Two years of filed business and personal tax returns. Depending on what type of entity you are is going to determine which documents we’re looking for, for income. If you’re a Subchapter S, say you’re a sole Subchapter S, you own the company, you’re going to receive income usually two ways. Through a W-2 if you pay yourself a wage, and through a K-1, which is going to be the ordinary income of the corporation. How we’re going to calculate that, we’re going to take two years of the ordinary income, and two years of the W-2 income, or we’re going to average it over 24 months, and that is going to be your income.
What we see a lot of times is maybe someone had a down year in 2013, and in 2014 they had a very profitable year, and now they’re looking for a home. Their assumption is we’re going to use the higher number for qualification, that’s not the case. We’re actually going to average that two year period, so that’s something that people need to know, and we address right up front, when we deal with a self-employed borrower.
Another thing we look at is year-over-year. How is the company doing year-over-year? We want to see the same, or an increase. A lot of times you’ll at a self-employed borrower, and they might have a decrease year-over-year. It might be minimal, it might be 5%, it might be 10%, that’s going to be a problem. When we look at it, the underwriter had to document that the business is healthy, and whenever we see a decline it gets very complicated on when I’m trying to document the health of the business. We have a special program, or special way to qualify those people, that we only use one year of business tax returns, and personal tax returns, if they have excellent credit, excellent assets, everything else looks okay. That’s something we would address on a case-by-case basis when we deal with that person.
Sole proprieterships, they’re not going to have a business tax return, per se, but they’ll file their income on Schedule C, Profit and Loss. It’s the same things, we’re going to take two years of whatever the profit hopefully from that business was, and we’re going to average that over a two year period, and that’s going to be the income. Some things that we can add back in are depreciation, so if your business is a trucking business, and you own a truck, you probably depreciate the truck, and that’s a non-cash expense that we can actually back into your income.
Those are all the details of how self-employed borrowers are different than employees, or wage earners, and how you really need to deal with someone that has expertise.