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March 8th, 2012

Tougher lending conditions for self-employed borrowers

by Peter Miller


Treasury Dollar BillMillions of self-employed borrowers are likely to get a nasty surprise the next time they try to apply for an FHA mortgage. Last week, HUD introduced a new standard for the income documentation needed from self-employed borrowers.

HUD’s new rule

According to Mortgagee Letter 2012-3, “P&L (Year-to-Date Profit & Loss) and Balance Sheet required if more than a calendar quarter has elapsed since date of most recent calendar or fiscal-year end tax return was filed by the borrower — with no exceptions.

“Additionally, if income used to qualify the borrower exceeds the two year average of tax returns, an audited P&L or signed quarterly tax returns obtained from IRS are required.”

Article: 10 critical questions for homeowners at tax time

Basically, the new standard means that ALL self-employed borrowers will need additional paperwork after March 31, even if they do not want a larger loan.

The new HUD standard may not be a problem for small businesses with bookkeepers and CPAs. However, many small businesses and self-employed taxpayers use neither. They keep their books on electronic spreadsheets, make quarterly estimated payments and figure out their balance owed in April.

Here’s what to do

If you are self-employed, you want to make estimated payments which reflect the business activity during the past quarter. You also want your four estimated payments to equal at least 90 percent of the tax paid in the past year–that way you can avoid a penalty for underpaying estimated taxes. (See a tax professional for specifics and details.)

The catch is that for millions of self-employed Americans, there is no audit of these estimates, in fact, there is no quarterly P&L statement. There’s just a good-faith estimate based on recent checks and the stack of bills growing in a shoe box.

It will be interesting to see what the National Federation of Independent Business and the National Association for the Self-Employed have to say about the new HUD rule. It’s a rule which creates a needless burden for the self-employed, is good news for the accounting industry and does little if anything to help HUD.

The old rule

The old rule stated that the self-employed must submit two years of past tax returns. No big deal–unless you claimed more income in the current year. Then, according to HUD, “either an audited P&L statement or quarterly tax returns are required to support the greater income stream used to qualify.”

In other words, if you earned $80,000 for each of the past two years and showed that amount on your tax returns, fine. If you estimated your income would also be $80,000 this year, that’s fine to, but, if things suddenly improve and you now expect to earn $100,000 this year, you need audited data from a professional (such as a CPA) and that can get very expensive.

The old rule was designed to prevent inflated mortgage claims and was typically resolved by basing the loan amount on the last two tax returns. There was no claim of additional income, no thought of a larger loan and mortgage rates were based on existing credit and market conditions. Everyone was happy.

Self-employed borrowers can still get a larger FHA loan with less paperwork, but only if they apply before March 31. After March 31, the first quarter will be over and borrowers would need audited statements.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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