Self Employed People Cannot Use Money From Their Own Business?

November 30th, 2012

business person money

The mortgage rule makers say that self-employed mortgage borrowers can’t use money from their business accounts for a mortgage. Not without some explanation anyway. Why? It’s their money! You would think they would know best what to do with it. Yet, Fannie Mae and Freddie Mac say that they don’t want a self-employed mortgage borrower to use funds from their business bank accounts without some further analysis.

What’s the problem?

Fannie Mae and Freddie Mac worry that taking assets out of a business bank account may materially and negatively impact the operation of the business. So they want further analysis as a result.

Is there a solution?

There is the possibility to allow the withdrawal of funds from business bank accounts. If the self-employed mortgage borrower’s accountant writes a letter stating that the withdrawal of funds from their business bank accounts should not adversely affect the operations of the business.

Some accountants object when approached for a letter like this. They feel it puts them on the hook. Yet, I have had many accountants write such a letter. And some other self-employed mortgage borrowers have chosen simply to use their personal bank accounts instead of their business bank accounts. Writing such a letter does not put an accountant on the hook when they use words like “should not” as opposed to “will not”. I know it still seems silly in some situations to have to get such a letter. But it is indeed a Fannie Mae/Freddie Mac requirement.

2018 UPDATE: There is a more specific rule to follow now, those guidelines are below.

“The lender may use discretion in selecting the method to confirm that the business has adequate liquidity to support the withdrawal of earnings. When business tax returns are provided, for example, the lender may calculate a ratio using a generally accepted formula that measures business liquidity by deriving the proportion of current assets available to meet current liabilities.

It is important that the lender select a business liquidity formula based on how the business operates. For example:

  • The Quick Ratio (also known as the Acid Test Ratio) is appropriate for businesses that rely heavily on inventory to generate income. This test excludes inventory from current assets in calculating the proportion of current assets available to meet current liabilities.Quick Ratio = (current assets — inventory) ÷ current liabilities
  • The Current Ratio (also known as the Working Capital Ratio) may be more appropriate for businesses not relying on inventory to generate income.Current Ratio = current assets ÷ current liabilities

For either ratio, a result of one or greater is generally sufficient to confirm adequate business liquidity to support the withdrawal of earnings.”

What does this mean?

This means that lenders now have to analyze how much cash is left in the business after the withdrawal of business funds for the new house purchase. And they must determine if the cash left in the business accounts meets one of the above ratios.

A real life example

I had one self-employed mortgage borrower who had $240,000 in her business accounts, and did not keep much money in her personal accounts. She ran a home based consulting business and was well established. During a refinance transaction an underwriter asked for her accountant to write a letter stating that the withdrawal of funds from their business bank accounts to cover the closing costs should not adversely affect the business.

Who could not see that a home based business with low overhead and minimal expenses could easily afford to take $4,000 out of her $240,000 business accounts to cover the closing costs on her refinance?! Keep in mind we had copies of her tax returns to show her business expenses were around $10,000 a year. She could not hurt her business by taking the $4,000 out of a business account with such a large balance. A circus animal could have made that call without getting a letter from an accountant!

You know what happened, don’t you? Yes, I got the letter from the accountant. There was no way around it per the underwriter.

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Brian Martucci is a loan officer for Capital Bank Home Loans, a division of Capital Bank, N.A. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. Brian Martucci – NMLS# 185421. His opinions do not necessarily reflect the opinions and beliefs of Capital Bank Home Loans or Capital Bank. Capital Bank, N.A.- NMLS# 401599. Click here for the Capital Bank, N.A. “Privacy Policy”.

One Response to “Self Employed People Cannot Use Money From Their Own Business?”

  1. Matthew Allen says:

    Hello Brian,

    I read your article about the liquidity test issues for self-employed borrowers. My wife and I are seeking to refinance our mortgage and we keep very little money in our personal accounts. The majority of our liquid assets are in checking accounts for our businesses (in excess of $350k in cash) between the two of us. Our lender is wanting to reject our application on the basis of “not enough personal liquidity” and refuses to consider the $350k+ in cash in our business accounts even though we could withdraw this money on a moments notice if desired because which each own 100% of our respective businesses.

    Any ideas for be GREATLY appreciated. We had a 2.95% lock and this is the only reason they are wanting to now deny the refinance.

    Thank you in advance for any thoughts or pointing us in the right direction.

    Best regards,
    Matthew Allen and Kate Edmonds

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