Self-Employed Borrower, Rental Income, and a Co-Signed Loan
Your borrower is a sole proprietor purchasing a $420,000 primary residence with 10 percent down on a 30-year conventional loan; total proposed housing payment (PITI) is $3,150. She provides two years of Schedule C. Year 1 shows gross receipts of $210,000 and net profit of $60,000, which includes $28,000 of depreciation and a $7,200 home-office deduction. Year 2 shows gross receipts of $225,000 and net profit of $65,000, which includes $30,000 of depreciation and a $7,200 home-office deduction. She also owns a duplex bought three years ago and rented under a long-term lease; Schedule E shows $18,000 in rents, $5,400 in operating expenses (including mortgage interest and taxes), and $6,000 of depreciation. Her monthly obligations are a $465 auto loan, $85 in credit card minimums, a $42,000 student loan on an income-based repayment plan with a documented $0 payment, and a $320 loan she co-signed for her brother; she has 10 months of canceled checks showing he pays it. The lender's overlay caps total DTI at 45 percent.
1. Calculate qualifying monthly income from the Schedule C and the duplex. Explain each adjustment you make and each you reject.
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Schedule C. Start with net profit and add back non-cash or already-paid deductions that depress reported income without consuming cash:
- Year 1: $60,000 + $28,000 depreciation + $7,200 home office = $95,200
- Year 2: $65,000 + $30,000 depreciation + $7,200 home office = $102,200
- Two-year average: ($95,200 + $102,200) / 2 = $98,700, or $8,225 per month
Do not add back the meals line: only the deductible 50 percent is on the return, and the disallowed half was never subtracted from net profit. Do not add back the business use of home twice or gross up gross receipts. Declining receipts are noted but not disqualifying at these margins.
Duplex. It has been owned and rented more than two years and there is a Schedule E history, so use actual Schedule E results rather than the 75-percent-of-lease shortcut reserved for newly acquired properties: $18,000 rents less $5,400 operating expenses = $12,600, plus the $6,000 depreciation add-back = $18,600 annually, or $1,550 per month. If the operating expenses already exclude the mortgage payment, do not deduct the mortgage again - the debt is captured in the housing ratio only for the subject property, not for the rental, but the rental's PITI must be verified as paid from the Schedule E figures. Total qualifying income: $8,225 + $1,550 = $9,775 per month.
2. The borrower has only 10 months of evidence that her brother pays the co-signed loan. How should the $320 be treated, and does the file pass the 45 percent overlay?
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Treat the co-signed debt as hers and include the $320. The standard for excluding a co-signed obligation is 12 months of documented payments made by the other party - canceled checks, bank statements, or a verified automated transfer history. Ten months of canceled checks is close but insufficient, and a letter from the brother is never enough. Counting it:
- Housing: $3,150
- Auto: $465
- Credit cards: $85
- Student loan: $210 (0.5 percent of $42,000, see next task)
- Co-signed loan: $320
- Total: $4,230
$4,230 / $9,775 = 43.3 percent, which fits under the 45 percent overlay - but only by about 1.7 points, roughly $165 a month of headroom. If the co-signed loan were excluded, DTI would be $3,910 / $9,775 = 40.0 percent, so the treatment is worth over three points and is the single biggest judgment on the file.
Because the margin is thin, do not stop at the ratio. Confirm the credit report shows no other undisclosed obligations, verify the duplex mortgage is current, and re-run the calculation at final underwriting. The wrong answer - excluding the debt because the borrower 'isn't really responsible' - is a misrepresentation to the investor, exposing the lender to repurchase and the originator to a fraud finding. The right path is to document 12 months of the brother's payments, or leave the debt in and let the automated underwriting findings speak.
3. What payment should be used for the $42,000 student loan with a documented $0 income-based payment, and why does the choice matter here?
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Do not use $0. A documented $0 income-based payment shows the borrower's current obligation, but it does not show that the debt is being retired; the balance can grow, and the payment resets on recertification. Agency guidance generally permits an imputed payment of 0.5 percent of the outstanding balance when the documented payment is $0 or the loan is in deferment or forbearance, which here is $42,000 × 0.005 = $210 per month. If the investor or the automated underwriting system requires 1 percent instead, the payment becomes $420.
Why it matters: the file is close to the overlay. At $210, DTI is 43.3 percent. At $420, total debts rise to $4,440 and DTI becomes 45.4 percent, which breaks the 45 percent cap. So the difference between the two imputed payments decides whether this loan is approvable as structured.
Practical handling: pull the servicer's statement showing the plan and the $0 amount, cite the specific guideline you are following in the file, and run the automated underwriting system with the same figure so the findings and the 1008 agree. If the investor's guideline is 1 percent, do not shop for a friendlier interpretation - restructure instead: reduce the loan amount, pay off or pay down the student loan with verified funds, or add a co-borrower. Documenting the reasoning protects both the borrower and the originator if the loan is later reviewed.