Tax season is upon us. Your self-employed customer will likely seek your advice whether they should wait until they file their most recent taxes before beginning their home search, or move forward using the last two years already filed.
As if your job isn’t hard enough.
Here is how you should always answer them…
IT DEPENDS!
Here’s the reasoning.
Generally speaking, income is looked at by lenders over a two year period.
For self employed and commissioned borrowers, the income is generally averaged over this period.
Here is the part that is often missed: The income is averaged if it is increasing year over year.
For example, if your buyer earned 65K net after expenses two years ago, and 80K in the most recent year, the income would be averaged at $72.5K annually as the income is increasing.
However, if the opposite is true, i.e. – $80K two years ago and $65K in the most recent year, the income would NOT be averaged.
In this case the income would simply be $65K. The borrower would receive no benefit of the higher earnings from 2 years past.
Why?
For underwriting purposes, declining income is not generally averaged especially when the decline is over 20% year over year.
For commissioned and self-employed, the income that is averaged is the NET income after all expenses are deducted, – NOT the top line gross income.
If your home buyer is in a declining income situation based on the returns already filed, and now have a higher income for the pending current tax year filing, then they may benefit from waiting to file the current year’s tax return.
Similar rules exist for rental income, part time jobs, side hustles, and other sources of variable income.
Fixed income such as pensions, social security, child support and salaried income are generally accepted at face value.
As with all things underwriting, there is no one answer for all situations.
The best advice is to have your customer sit down independently with their loan officer to review their current and future income expectations.
He or she can analyze your home buyer’s filed returns and review with your buyer the derived income that would be used for underwriting purposes.
Your homebuyer should also consult their CPA or tax preparer for guidance on what the upcoming year returns may look like.
Armed with these independent pieces of information, your buyer can make an educated decision to move forward as is or hold off to complete the most current years filing.
For you, you have a buyer you know will not experience any income related challenges in the middle of your sale.
Need further info? Contact us with any scenario you may have.