Income fluctuations / DTI / Qualifiing for Conventional FHA?

Question

Hello All,

So far I have been buying rentals with my self directed IRA, but would also like to do some with conventional 30 years fixed financing before rates get too high.

When I looked into it this year, even though I had plenty of cash for the 20% down I was told my debt to income was too high. As a summary my house PITI runs about 48% of my income the last several years. I am self employed in a partnership and have only taken a 'minimal draw' of about 30K per year to make ends meet as we paid down our business line of credit that we had to dig into very deeply at one point of the housing slow down (we do construction). That is paid off now, and business is picking up to the point that we will make a decent profit over and above the draws we have been taking home.

What I am wondering is that we have some leeway in when we take in some of the progress payments on jobs (receivables). Would I be better of, in regards to qualifying for rental financing, to take say an extra 18K on this years income, which would put my DTI down to about 32% or so, or up my monthly draw in 2017 to say 4K instead of 2.5K?

My preference would be this this year, but just wondering if that makes the most sense?

One other wrench to through into all of this is that I received an inheritance that I am planning on using to max out my SOLO401K this year and next also to the tune of 24K each year. Not sure how that affects AGI as it comes off 'above the line', I think.

Maybe @Chris Mason or @Albert Bui could chime in on how you all see this as lenders?

Thanks, Dan Dietz

Albert Bui · Answer

Im not a tax professional but I do work with financial planners and accountants. On some of the cases I've worked on I've learned that income from partnerships is a flow through to your personal returns (LLC, LP, Scorp, etc - entities where you get a K1 ) so no matter if you take a 'draw,' or not we still see the income on your personal return in one form or another and it will be subject to tax. This income can be used to qualify for a conventional loan. There are also a lot of non cash deductions that can be added back as well like amortization, depreciation, and depletion. Non cash add backs make your income look better and count as a tax deduction so its the best of both worlds.

You may keep the earnings or profit as "retained earnings," but its still shown on your tax returns either as 1099, W2, or distrubtion via k1.

On the conventional side we add up the 2015 and 2014 totals for 1099/W2/K1's and average them for each individual business, operation, or entity or if the most recent 2015 year is worst then we'll just average 2015 by 12 months to determine your monthly income.

This is done for each entity or business or property.

As a side note personal contributions from the employee side to your 401k is not counted against you but the employer contribution is so when you're doing your tax planning with your accountant you may want to shift or strategically plan this accordingly depending on what income you want to show on the lending end.

Hope that helps.

Albert Bui · Answer

To put it succinctly, there are only two ways to reduce your DTI, you would either need to increase your income or net profit or reduce your expenses to improve your DTI.

Messing with the draws doesn't do anything since the income from flow through entities end up flowing through anyway.

If you had a C corporation where you don't get a K1 then yes retained earnings and managing your draw does have an effect on income coming out of the entity, but then you'll also have double taxation of a corporation to deal with as well but that is another story....

Albert Bui · Answer

Yes to 401k and yes in general to all else above.

In general yes it would be calculated like that and it could be as high as 60k as well if you use a 1 tax return (if you're self employed).

In most cases, you'd average the two most recent years or take the worst year divided 12.

Using the 1 year tax return you can use the most recent tax return and divide by 12 even if the most recent year is better.

A lot of underwriters don't understand the W2 and K1 and why you have both so just make sure you know how to explain it or the lender knows how to explain it to the underwriter because confusion usually leads to worst case results when underwriting (most conservative).

Daniel Dietz · Answer

@Albert Bui thanks for all the info! I think I follow most of what you are saying. I understand that it will show up on my K-1, but am wondering which YEAR it would be most beneficial to me, in regards to qualifying for a conventional loan.

To make sure I am following what you are saying, let me give you this scenario;

2015 Income 30K, 2016 Income 40K,  Anticipated 2017 Income 40K. There is ALSO going to be an additional 20K or so that I have as 'receivables' from jobs currently in progress that I could collect either yet in 2016 or wait until 2017 (jobs that are carrying over into the new year).

It sounds like from what you are saying is that if I wanted to apply for a conventional loan in early 2017 that I would be best off to get those receivable collected and on my 2016 taxes so I would have a total income of 40K+20K= 60K total income. I would then be doing a SOLO401K contribution of 24K that would reduce that down to 36K of AGI. Since that is an 'employee' contribution would that then be added back for DTI purposes?

When I apply for the loan, a lender would look at 2015 income of 30K + 2016 income of 60K and average it out to 45K  or $3750 per month. It looks like this would put my DTI at about a 25% for housing + 8% vehicles for a total of 33% or so. I assume this would be a much better spot to be than my previous 48% or so :-)

Thanks again,

Dan Dietz

Income fluctuations / DTI / Qualifiing for Conventional FHA?

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