Howdy, Partner! How's the Income Look on Your Mortgage Application?
I don't care how successful your S-Corporation or partnership may be. When you go to get a home loan, there will be a new sheriff in town --- your mortgage lender. So before your loan process gets hung up at high noon, I thought I'd let you in on a secret about how most lenders will qualify your income. Let's go, amigo. We're burnin' daylight.
Most of what we focus on below will pertain to the self-employed partner or owner in an S-corp. The widely-accepted definition of 'self-employed' is greater than a 25% ownership interest in any business entity. So, look at your K-1 form if you don't already know. If your ownership interest exceeds 25%, you can expect that your mortgage lender will ask you for not only your personal income documentation (as applicable); paystubs, W-2 forms, K-1 forms and personal tax returns (1040 Federal Tax Return), but also the Federal tax returns of the business entity itself. In the case of a partnership or LLC, this will be a Form 1065 and in the case of an S-Corporation, this will be an 1120S. "But wait!" you say, "They can claw the business returns out of my cold, dead hands!" OK, that's why we're having this conversation, partner. Get this straight with your tax professional and the other owners before finding yourself in this one-horse town. If you're greater than a 25% owner, we need your business documents too.
Assuming you're greater than a 25% owner and we now have the ability to review your documents, we're going to start analyzing your income by reviewing your K-1 forms. A very key piece of your qualification, and one that most do not know about, is that we are primarily looking for distributed income. Owners who receive ordinary income (Box 1) but do not have distributed income will often have difficulty qualifying with K-1 income. Yes, they could still qualify with so long as the business itself is not showing a loss in that year(s), but frequently a business owner will have both compensation to officers (W-2) and K-1 income. When income is not distributed, we will next turn to the balance sheet on the business tax return and seek to prove business liquidity. We will almost always require additional support from the tax preparer to state that distribution of previously undistributed income would not cause financial harm to the business. These kinds of requirements often rankle not only the tax preparer but the business owner himself/herself. So again, before galloping into this town, guns a-blazin', have your posse ready to save your hide.
The OK Corral
Here's what I find most often. If a business (partnership, LLC or S-corp) is doing well and paying both wages and distributed earnings to its owners, it's a fairly straightforward qualification. Yes, there is more documentation required but if the business keeps good books, none of this is tragically problematic for the borrower. Where a business is not distributing earnings, things can get a little trickier, but certainly not impossible. Lastly, and thankfully more rarely, are businesses where they are paying out wages (W-2 earnings) but posting a loss on the K-1 and/or business returns. These borrowers should expect for that cover to be blown shortly after getting out of the saddle.
If you are a self-employed business owner, especially a partner, LLC member or S-Corp owner and you are having difficulty getting a great loan, don't assume that your loan officer understands how to qualify your income. Sadly, many in our profession lack the knowledge, expertise and experience and there is no education or licensing requirement that could assure you they know what they're doing. Ultimately you would find out once your loan goes through underwriting, though you may not have the luxury of waiting. If you need clear, expedient answers on these scenarios, whether you are a borrower yourself or a tax professional assisting a borrower with a mortgage application, get in touch any time and I'll be happy to help.
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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