Sometimes guideline changes can be hidden in plain sight. While working on some training updates recently, one of those changes popped out at me, and these changes will be disruptive!.
K1 vs Distributions
Remember when, a little over two years ago, Fannie Mae changed a rule relating to self-employed borrowers? In our training videos, I now refer to it as the “big D question”— what number should be used: the K-1 income or the distribution K-1 income? This change, made by FNMA and followed soon after by FHLMC, had us reconstructing spreadsheets and remaking training videos to cover the ‘new’ income calculation concept of verifying distribution income to 1065 and 1120S business owners.
Similarly, Allregs FHLMC 5304.1, dated 02/09/2018, which pertains to stable monthly income and documentation requirements for self-employed borrowers, is having that same disruptive effect. Freddie’s guidelines contain a few paragraphs that underwriters need to pay close attention to.
What does it mean?
What this means in regards to qualifying self-employed borrowers is that those cash flow adjustments to the borrower’s income like depreciation and depletion (among others)—that I have been making since starting the mortgage business in 1994—should no longer be used in most cases.
We all know how depreciation and other business adjustments have gotten a self-employed business owners over the “DTI Hump” many times in the past. Based on the wording, these new rules apply to 1065, 1120S, and 1120 businesses. That last highlighted bit might seem attainable, but in my experience it is nearly impossible to get that documentation. I have reviewed many corporate agreements and I cannot remember any of them stating, “partners or shareholders shall divide tax savings from depreciation and depletion shall be divided and distributed as income”.
As underwriters, we have to stay diligent to the rules changes but sometimes those changes can sneak in under the radar, not having a lot of fanfare or press that says, “Hey look at me. This is going to substantially change the way you have to do things.” Sometimes, they seem hidden in plain sight in the guidelines.
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