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December 2009 3
Agenda
Self-employed borrower risk and Seller
responsibility
Freddie Mac’s definition of a self-employed
borrower
Types of businesses that need to be analyzed
Requirements for analyzing the business and
income
Mortgage file documentation requirements
Loan Prospector® data requirements
Resources
December 2009 4
Self-employed Borrower Risk
Why is more analysis
required for a self-
employed borrower?
December 2009 5
Seller Responsibility for Self-employed
Borrowers
What Is the
documentation do business
you need in the financially
mortgage file? sound?
What’s required
for the income
analysis?
December 2009 7
Who is a self-employed borrower?
December 2009 8
Income Exercise - Mary
If Mary owns 33 percent of a small family-owned pastry
shop, but is employed full-time as an accountant and
doesn’t need the income from the family business to
qualify, do you need to analyze her tax returns?
a) Yes
b) No
Why or why not?
December 2009 9
What are the various types of business
structures that need to be analyzed?
There are three basic business types with
variations you need to analyze:
Sole Proprietorship
Partnership (General and Limited)
Corporation
General
S-Corp
Limited Liability (LLC)
December 2009 10
Sole Proprietorship
Tax Returns You’ll Need
Business owned by one owner to Analyze
Easy and inexpensive to establish Form 1040, Individual Tax
Return
Income is reported on Schedule C Form 1040 Schedule C,
Profit or Loss From
of Form 1040 Business
Income is taxed at owner’s
personal tax rate
Business income is taxed at personal rate
Typically considered a more risky business classification
due to owner’s unlimited personal liability for all business
losses
Typically unable to raise large sums of money for
reinvestment
December 2009 11
General and Limited Partnerships
Business owned by two or more Tax Returns You’ll Need
to Analyze
partners
Form 1040, Individual Tax
Income reported on Form 1065 Return
(income is carried forward to Form 1040 via Form 1040 Schedule E,
Schedule K-1) Supplemental Income and
Loss
Owner’s income is reported on Part
II of Form1040 Schedule E Form 1065 Return of
Partnership Income
All income is passed through to Form 1065 Schedule K-1,
partners who pay at personal rate, Partner’s share of Income,
partnerships pay no tax Deductions, Credits, etc.
December 2009 13
S-Corporation Tax Returns You’ll Need
to Analyze
Can have up to 75 shareholders
Form 1040, Individual Tax
S-Corp files Form 1120S Return
Form 1040 Schedule E,
Shareholder’s income is Supplemental Income and
reported as a distribution via K-1 Loss
on Schedule E of Form 1040 Form 1120S, Income Tax
Return for an S Corporation
The S-Corp pays no tax on Form 1120S Schedule K-1,
income; all income is passed Shareholder’s share of
Income, Deductions,
through to its shareholders Credits, etc.
December 2009 14
Limited Liability Company (LLC)
First introduced in the US in 1988 as Tax Returns You’ll Need
to Analyze
a “pass-through status”
Will depend on setup of tax
Advantages: entity; typically like a
Flexibility in organization and management partnership:
Form 1040, Individual Tax
Protection of personal assets from
Return
business debts
Form 1040 Schedule E,
Taxed at personal level Supplemental Income and
Are not restricted like S-corporations, Loss
which makes them attractive to foreign Form 1065 Return of
investors Partnership Income
Corporation No limit Form 1120 Wages line of Corporate income is Shareholders are not Double taxation issue: corporate
on Form 1040 or taxed at corporate rate. personally liable for the income is taxed at corporate rate. If
number their W-2 If this income is paid to corporation's debt. income is paid to shareholders as
of share- share holders as Easy to transfer ownership dividends, this income is again taxed at
holders dividends, the share (sell shares of stock). their personal rate.
holders pay tax on it at
personal rate.
S-Corp Up to 75 Form 1120S Part II of S-corporation pays no S-corporation pays no tax on No more than 75 shareholders; limits
(Combination share- Schedule E on tax on income. All income. All income is taxed the raising of capital from a large
of partner- holders Form 1040 via income is passed at individual shareholders' number of investors.
ship & K-1 through to individual personal rate.
corporation) (distributions) share-holders who pay No double taxation.
tax on income at their
personal rate.
LLC No limit The forms necessary Part II of All income is passed Combines the limited liability Forming an LLC is more expensive
(Limited on for filing as an LLC Schedule E on through to individual protection of a corporation and than a partnership or a sole
Liability number depend on the type of Form 1040 via shareholders who pay the pass through taxation of a proprietorship. Does not offer the free
Company or of share- federal tax entity that K-1 tax on income at their sole proprietorship or transferability of owner-ship, perpetual
Corporation) holders is either elected or (distributions) personal rate. partnership. existence, and the ability to be totally
defaulted to. owned by a single individual that one
Most LLCs with more gets with a corporation. State statute
than one member file frequently limits the life span of an LLC
a partnership return, to less than 30 years. If maintained
Form 1065. beyond that, the IRS may consider it to
be a corporation.
December 2009 16
Business Types – Where’s the Greatest Risk?
A sole proprietorship is typically
considered to be more risky due
to owner’s unlimited personal
liability for all business losses
General partners also carry
personal liability for all partnership
debt and losses
A corporation is often the least risky
because the owner is not personally liable
for the company’s debt
December 2009 17
Is there Stable Monthly Income?
Stable monthly income (qualifying income) is the borrower’s
gross monthly income from all verifiable sources that is
reasonably expected to continue for at least the next three
years. In order to consider the income stable, the borrower
must have a two-year history of receipt, in most instances.
The determination that the income is expected to continue
must be based on:
Occupation
Tenure
Past employment history, and
Probability of consistent receipt
The existence of the business must be verified by a third party
source no more than 30 days prior to the Note Date
December 2009 20
If Relocating to a Different Geographic Area…
Consider the acceptance of the company's
service or products in the marketplace before
considering the income for qualifying purposes
Document and explain how you determined that
the Borrower's income will continue at the same
level in the new location
December 2009 25
Example of a Written Income Analysis Tool
Instructions for
Income Analysis
Form 91
Provides line
item direction for
completing
analysis
Separate forms
should be used
for each
borrower to
complete
analysis
December 2009 26
When Analyzing the Business, Consider…
The ability to add back certain items on tax returns to
the adjusted gross income when determining
qualifying income such as:
Depreciation
Depletion
Amortization
Documented nonrecurring losses, such as casualty losses or
carry-overs from previous years
Income increases or decreases over the previous two
years – what is the income trend?
Note: If using business assets for down payment, financing costs, prepaids/escrows and
closing costs, the assets must be:
Verified in accordance with Guide Sections 37.20 - 37.23
Related to the business the borrower owns and documented in the mortgage file
Guide Section 37.13 (b)
December 2009 27
Income Trend – Are there Significant
Increases or Decreases in Income Level?
Income
For example:
1077 Underwriting Comments Section
December 2009 31
Loan Prospector Documentation Matrix
www.FreddieMac.com/learn/pdfs/uw/docmatrix.pdf
December 2009 32
Income Exercise - Marion
Marion has owned his own landscape business for the
last 5 years. The business operates as a sole
proprietorship. According to his tax returns, Marion's
income, after adding back noncash expenses, was
$28,000 last year and $32,000 for the previous year.
December 2009 33
What are Loan Prospector’s data requirements?
1. Indicate self-employed for each borrower who has 25% or more
ownership in a business, regardless if the income is used to qualify
2. Enter the total amount of self-employed income used for qualifying*
3. Include the amount of self-employed income in the total monthly
income*
3. 1.
2.
*If using the Monthly Income Breakdown, enter the amount of self-employed income in an
appropriate field so Loan Prospector automatically includes the self-employed income in the
Monthly Income total
December 2009 34
Loan Prospector example
Shawn manages a sporting goods store earning $4,500 per month. For the last several
years, he’s owned a small tree trimming business. His tax returns from the previous two
years indicate this business has been providing him with an average of $1,000 of additional
income per month. How would you enter Shawn’s employment information in Loan
Prospector if:
1. Using Shawn’s income from the tree trimming business to qualify?
2. You determined the tree trimming business income wasn’t stable enough to use?
1.
2.
December 2009 35
Recap – Reminders for Responsible Lending
1. Determine your borrower’s ownership interest in the
business(es)
2. If 25% or more ownership interest, indicate self-employment in
Loan Prospector or manually underwrite as self-employed
3. Obtain the documentation required by Loan Prospector’s
documentation level, or the Guide if manually underwriting
4. Analyze the documentation to ensure financial stability exists
(additional documentation may be required if unable to
determine stability with minimum documentation
5. Obtain signed IRS Form 8821/4506/4506-T
6. Provide a written summary on your analysis of the business on
Form 1077 or similar and include your income analysis showing
how the income was calculated
December 2009 36
Additional Resources
Freddie Mac’s Single-Family Seller/Servicer
Guide Chapter 37
Your Freddie Mac Representative
1-800-FREDDIE
www.IRS.gov/
Mortgage Insurance Company resources
December 2009 37
Learning Center Updates
The Learning Center Updates page provides quick access to new and updated
resources to help you with underwriting, mortgage products, selling, servicing, and more.
View a summary of recent changes at www.FreddieMac.com/learn/ch_ind/
Also
FREE!Subscribe!
at
www.FreddieMac.com/learn/subscribe
Please complete post-session survey that appears to the right of this slide
December 2009 39
Thank you for your participation!
Notice
This document is not a replacement or substitute for the
requirements set forth in the Freddie Mac Single-Family
Seller/Servicer Guide (Guide) and/or terms of your Master
Agreement and/or Master Commitment.
December 2009 40