Self-employed underwriting: 25% rule "loophole"?

Question

Hello folks! I have a question about getting a mortgage underwritten as a newly self-employed person.

I recently decided to leave corporate hell and started a one-man, one-owner corporation. I pay myself a base W2 income plus a variable bonus every month.

Unfortunately, self-employment is not looked upon favorably by lenders as it is not considered stable income without at least one full year of evidence to the contrary. So I'd really like to avoid being classified as self employed!

The Fannie Mae underwriting guidelines define a self-employed person as follows:

• Any individual who has a 25% or greater ownership       interest in a business is considered to be self-employed.

So, suppose I sell or otherwise transfer 76% ownership of my corporation to another person, perhaps an uninvolved family member. Is it really true that I'm now just a normal W2 employee for underwriting purposes? That would make getting approved heaps easier... so much easier that my proposed solution seems fraud-level "gamey" and I suspect a lender would see through it.

What do you folks think? Is this a valid "loophole" to avoid being treated as self-employed? Thanks very much for your perspectives!

Eric Veronica · Answer

@Joe Maron if the internet did not exist it would be a little easier to pull this off. Most state's have a dept of commerce where filings are easily found. If an underwriter thought that there was something fishy going on it would be very easy to look at the filing history. Underwriter could see the initial articles of incorporation which was filed by you and then they would see the change of resident agent which shows you transferring the ownership right before you applied for a mortgage.

Below is a sample of what the the Michigan filing system looks like. If you click on the links all the way to the right you can pull up every filing. What you are asking might not be considered fraud but it definitely lives in that neighborhood.

Below is a sample of what the the Michigan filing system looks like.  If you click on the links all the way to the right you can pull up every filing.  What you are asking might not be considered fraud but it definitely lives in that neighborhood.

Jeff Dulla · Answer

@Joe Maron Most lenders have underwriters/underwriting departments that are digging into all kinds of things. They will pull records on the company to see who started the business, what owners/officers are out there, etc. While it is true that if your ownership on a K-1 is less than 25%, they will potentially give you credit for a salary and interpret you as an employee rather than an owner, it isn't as simple as that. There will be more items that the underwriter will request/look through. The burden of proof will be on you to prove, beyond a doubt, that you are in fact only a smaller owner in the company, that the vast majority of your earnings come from salaried work you do for the company and not work that you do as an owner/facilitator of the business. From what you said above, I am not sure you will be able to prove that.

Stephanie Medellin · Answer

@Joe Maron  If you are employed by a family member you will be scrutinized more than a regular W2.  They will also want to know that you don't have any ownership interest in the company.  I wouldn't advise trying to deceive the lender by trying to create loopholes.  Are you in the same line of work?  You may be able to find a loan with one year tax returns.

Jeff Dulla · Answer

@Joe Maron Not 100% sure if this would go through perfectly but I would say If you can prove it and it makes sense, not sure they could combat it. Meaning you would have to have proof, maybe from a contract that was fully executed, that these people bought the other 80%. The underwriter would probably also want an attorney or CPA to independently verify in writing that this happened and is the current structure. Long story short you would need to provide a substantial amount of proof that this was done.

Joe Maron · Answer

Thanks everyone for your thoughtful and insightful responses! It makes sense that the "loophole" I perceived would fall apart even under light scrutiny. I certainly wouldn't want to deceive anyone that I do business with, so I will not pursue this idea further. @Stephanie Irto  Good idea. The Fannie Mae guidelines do state that it's possible to get approved with 1 year tax returns if you remain in the same field -- the major caveat being that you need to earn at least as much as you did at your last position. Fingers crossed on that!

@Eric Veronica That's a great point. With that filing information, I think anybody with half a brain would identify this behavior as something  akin to a straw purchase.@Jeff Dulla I appreciate your nuanced response! It raises a related question: suppose that I have a legitimate reason to restructure my business. For example, I bring in four non-employee investing partners, such that the five of us have 20% stakes in the corporation. As the sole employee of the corporation, yet working at the behest of the board, am I still considered self-employed? Does it come down to specific guidelines or just a "smell test"?

Self-employed underwriting: 25% rule "loophole"?

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