June 09, 2020

Self-Employed Borrower’s Income – Is the Past Necessarily Prologue?

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In a new era of double-digit unemployment resulting from the COVID-19 pandemic, it may be tough for a mortgage lender to predict the amount and stability of someone’s income in order to determine qualification for a home loan. Neither past nor even present levels of income may be reliable indicators of income levels going forward, at least in the short run or until the economic dislocations are substantially behind us. That is why Fannie Mae and Freddie Mac (the “government-sponsored enterprises,” or “GSEs”) recently issued enhanced documentation requirements and considerations for verifying and predicting the income of a self-employed applicant for a mortgage loan. While the GSEs’ documentation requirements apply via contract to approved lenders/sellers, whether those requirements will morph into legal requirements under the Dodd-Frank Act’s “ability to repay” requirements is something to watch in the coming months.

Revised GSE Underwriting Requirements for Eligible Loan Purchases

A determination of whether an applicant has the ability to repay a loan from his or her income or assets is a basic component of loan underwriting – as required both by federal (and sometimes state) law, and by a lender’s investors or insurers. In addition, federal regulations prohibit a lender of closed-end residential mortgage loans from relying on any income that is not verified by reliable documentation. Predicting whether that income will continue into the future takes skill when lending to self-employed borrowers under any circumstances, and is particularly tricky during this unique coronavirus economy. The now-waning government stay-at-home orders and other quarantining efforts may or may not have affected a particular borrower’s business operations, and the scale and duration of those effects going forward are difficult to predict.

In response to that uncertainty, on May 28, 2010 Fannie Mae and Freddie Mac issued guidance requiring that self-employed borrowers must submit a year-to-date (“YTD”) profit and loss statement (“P&L”) that reports business revenue, expenses and net income. Continue Reading

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