In the Introduction, we discussed the various types of business you may see when underwriting and documenting for a self-employed borrower. In this learning clip, we will focus on general and limited partnerships.

Please remember that you are responsible for determining if your borrower’s income documentation demonstrates that he or she will have the financial ability to repay the mortgage.

The following chart describes the tax reporting information and advantages/disadvantages of a general and limited partnership.

Cathy and her clientele

Cathy is a 17% limited partner in a retail crafts store for pets. Her income is based on the profits of the partnership. The documentation level returned by Loan Prospector is Streamlined Accept.

Below is an example of a partnership return (Form 1065). As you can see on Line 10, there is a 'Guaranteed payments to partners' of $5,000.00. This payment will appear again in Schedules K, M-1 and M-2 of this Form 1065, and also on Cathy's Schedule K-1. Cathy is entitled to use 17% of the business depreciation on Line 16c.

This 1065 also shows 'ordinary business income' on Line 22 of $211,066.60. Whether or not Cathy, as a 17% owner, receives any of this would depend on the partnership agreement. If you wanted to use a portion of these funds you would need to review the K-1 which is part of her individual returns. All monies distributed to the partner are reflected there.

Page 2 of the return shows less inventory than in 2004—is this important? Maybe. If the need to replenish inventory would result in the need for an additional capital investment from your borrower, there may be a negative impact on the stability of her earnings in the near future. In this case, it would not appear there would be a need to address further.

When reviewing the returns, make sure you look to see if the numbers carried over actually match. If not, ask why. As previously stated, inconsistencies in amounts carried over from schedules are typically red flags that fraudulent or altered returns have been provided. Talk with your QC area or manager to determine what action you should take if this occurs. [To play movie, click right blue arrow below]

This page shows the balance sheet for the business, which can help you determine if the company is solvent or not. In this case, notice the increase in cash on Schedule L, line 1(b) vs. line 1(d) —almost double. Is this company solvent? It appears so! This is additional support for our previous conclusion that there was no need to be concerned with the drop in inventory. The company clearly has the cash flow to invest in additional inventory when needed.

This is Cathy's Schedule K-1. Line L in Part 2 confirms she is a 17% limited partner. Line N shows both her initial capital investment and any capital investments made. If capital investments were made in the most recent year, you may need to request additional returns to see if there is a pattern that could impact earnings. This is an example of when additional documentation may be needed. Prior years' personal returns may be needed to support that this was a one-time need or if it happens often.

Box 1 in Part III provides the ordinary income she received from the business and box 4 shows the guaranteed payments. These amounts would transfer to Schedule E of the borrower's individual returns and ultimately be summarized on line 17 of the first page of your borrower's individual return.

Back to Underwriting Self-Employed Borrowers