When doing a mortgage loan under the Appendix Q guidelines, we have been told a Balance Sheet is required, even for a Sole Proprietorship. I thought there was no legal distinction between the Sole Proprietor and their business. So doesn’t the personal financial statement include the sole proprietor balances? And are we required to obtain a separate balance sheet for sole proprietorships?
Maybe. Don’t you just hate that! First, let me acknowledge that Appendix Q has requirements that are confusing and even a few statements that I believe to be inaccurate. That said, it is the law of the land.
What is Appendix Q?
As part of the Consumer Financial Protection Bureau’s (CFPB) Ability-to-Repay (ATR) Rule, regulations were developed requiring mortgage lenders to consider consumers’ ability to repay loans before extending credit under the Qualified Mortgage (QM) rules. By following the QM rules, the creditor is generally protected against the buy-back rules if a borrower defaults.
Creditors must verify the information using reliable third party records. Appendix Q contains the standards for determining monthly debt and income.
Do we need Sole Proprietor Balance Sheets for QM?
Yes. This is a requirement in addition to the 1040 tax return and includes year-to-date income statements (after the tax return date) and balance sheets.
Are the personal and the business balance sheets combined?
Could be. You are correct that the two ‘entities’ are not actually separate. That said, I have always created a Balance Sheet for the business separately, and prefer it. Then the personal financial statement will have an asset that is ‘Business Capital’. That makes it easier to assess the business strength, in my opinion.
The question you did not ask, Paula.
Do all mortgage loans have to qualify as a QM loan? Again, it depends. But some lenders are doing quite well making non-QM loans, and they are completely allowed by the CFPB. Normal and prudent underwriting standards must be followed. And if it is a secondary market loan, you need to follow the guidelines of the lender.
Some mortgage loans are too large for the QM rules. In some cases, the debt-to-income (DTI) is higher than the allowed 43%, but well within your comfort level. Perhaps the individual is very high income with a credit rating of 780, plenty of liquidity, a 55% Loan-to-Value (LTV) and at 48% DTI. You might happily make that loan all day long, but that won’t fit the QM criteria.