Bank Statement Programs: 7 Methods Lenders Use To Calculate Income

Navigating bank statement loan calculation is key for many without traditional income proof like W-2s. Our guide explains how lenders assess your mortgage eligibility. This doesn’t mean they don’t have income. Clearly, they do. The lender just verifies it under a bank statement program, rather than via the more typical income verification process. Instead of looking at income from employment, the lender goes through bank statements and looks at your history of deposits.

Bank statement programs are just one of many popular mortgage programs specially designed for self-employed borrowers.

A bank statement program may be a great fit if you are:

• Self-employed or an independent contractor
• A business owner
• Work on commission
• Work in a cash business or earn a lot of cash tips
• Your income is seasonal
• You have a non-traditional source of income
• You have lots of cash flow, but you write off a lot of expenses

A bank statement program might also be a great solution if you have a recent increase in income but not a great income history.

To qualify under a bank statement loan program, you’ll generally need to provide 12 to 24 months of bank statements. Depending on circumstances, you may also need a letter from a CPA verifying how long you’ve been in business, the nature of said business, your percentage of ownership, and other details.

If your unconventional income adequately covers your mortgage payments and other expenses, you may qualify for a loan of up to $10 million or even more. And you won’t need to provide tax returns, W-2s, or other conventional forms of income documentation. 

Key methods for bank statement loan calculation by lenders

Bank statement programs are tremendously flexible. Lenders use a variety of methods to estimate your income available to cover your mortgage obligation and the other costs of ownership. 

Not all your bank deposits will be countable as income under a bank statement program. To be eligible for the program in the first place, at least one of the applicants must get most of their income from self-employment, specifically. Depending on the lender, this may exclude income from rental properties.

Self-employment is usually defined as a business reported using an IRS Schedule C, or a direct ownership interest of at least 20% in a limited liability company (LLC) or corporation.

The lender will look for a self-employment history of at least two years. However, you can still qualify with less than two years’ self-employment history if you were previously employed in the same line of work, and you have an improving income history.

Once the lender is satisfied that you meet their self-employment criteria for a bank statement loan application, they will then go over your most recent 12 or 24 monthly bank statements to verify or estimate your income.

Every lender is different. But in general, lenders that offer bank statement loans will apply one of these seven basic methods, depending on your situation and the documents available:

1. Personal accounts
2. Commingled business and personal accounts
3. P&L plus business accounts (3 months’ statements)
4. P&L plus business accounts (12-24 months’ statements)
5. P&L only
6. Bank statements plus licensed tax preparer certification of expense ratio
7. Variable expense ratio 

Here is a more detailed look at each underwriting method and the documents you’ll need to submit to get approved. 

Method 1: Personal accounts

Under this method, you would submit your most recent 12 months or 24 months of personal bank statements, as well as the most recent 2 months of business bank statements that show transfers to your personal account. 

You should be prepared to document any unusual deposits, including very large deposits or deposits in ‘round numbers.’ This is because round number deposits may indicate something other than business operations income, such as loan proceeds or outside investments.

The lender will count direct transfers of net business income from your business account(s) to your personal account(s) as income for purposes of qualifying for the mortgage. 

It’s important to differentiate here between net business income and gross business income. If you are depositing gross business income into your personal account rather than net business income, that may indicate to the lender that your account is actually a commingled business and personal account or a business bank statement, rather than a completely personal account.

They would then use a different methodology to compute your income, such as Method 2, below.

Method 2: Commingled business and personal accounts

If you have a single account reflecting both personal and business income and expenses, this method may be appropriate for you. However, the lender will only credit deposits attributable to the business as income. Non-business or non-recurring deposits won’t count towards income – though in some cases they will count continuous sources such as annuity payments, pensions, disability insurance payments, alimony, and other recurring sources of revenue.

Like the personal accounts method, the commingled business and personal accounts method will be based on your most recent 12 or 24 months of bank statements. Additionally, you can expect to provide at least 2 months of business bank statements, as well.

The lender will also calculate your business expenses under this method in order to estimate your net income, as opposed to your gross. Recurring monthly expenses should match with line-item profit and loss expenses (if applicable), or be consistent with the expense ratio used (if applicable).

Method 3: P&L plus business accounts (3 months’ statements)

You can also qualify for a mortgage under the bank statement program using a combination of a P&L and your bank statements. Here, the lender will require a P&L statement (covering a 12-24 month period) signed by a licensed and certified tax preparer (e.g., a CPA or Enrolled Agent). This may require submitting a year-to-date P&L along with the two previous annual year-end P&Ls.

You will also be required to provide the last of your three most recent consecutive bank statements.

Your bank statements should be consistent with your P&L statements. You should be prepared to explain or document any discrepancies.

More specifically, bank deposits must be within +/- 10% of your P&L statements. However, if there are discrepancies in one or more months, you may submit additional consecutive bank statements until deposits and P&Ls are within the 10% requirement. 

You may also be required to provide a business plan or other documents detailing further information about your business. Individual lenders vary in their requirements, but typical items might include:

• A description of your business model
• Types of goods and/or services provided
• Overhead expenses
• Recurring or typical expenses
• Lease or rental obligations
• Information about your client base
• Number of employees

Under this method, the lender will calculate your monthly income as equal to the average of the monthly 12 or 24+ months’ net income (after expenses) on your P&L statements.

In practice, these loans are capped at 80% loan-to-value (LTV) or sometimes 90% LTV. In other words, if the LTV is capped at 80%, you can expect a down payment of at least 20%, or you’ll have to finance at least 20% using other sources. For a higher cap, consider providing more bank statements, so the lender can calculate your income using Method 4 below.

Method 4: P&L plus business accounts (12-24 months’ statements)

This method is similar to Method 3, above, except you would provide 12 or 24 months’ bank statements instead of just 3 months. Because the lender has access to more information, the risk to the lender is reduced compared to the 3-month bank statement method. That means you may qualify for a greater LTV, or better terms. 

The lender will require 12 months’ or 24 months’ worth of professionally prepared and signed P&L statements from your accountant, enrolled agent, or other professional. The P&L statements need to run through the time of your most recent bank statement. This may require preparing a YTD P&L statement in addition to the previous year-end P&L.

Again, bank deposits must be within +/- 10% of your P&L statements. However, if there are discrepancies in one or more months, you may submit additional consecutive bank statements until deposits and P&Ls are within the 10% requirement.

You can also expect to provide a business plan or other documents detailing further information about your business. Individual lenders vary in their requirements, but typical items might include:

• A description of your business model
• Types of goods and/or services provided
• Overhead expenses
• Recurring or typical expenses
• Lease or rental obligations
• Information about your client base
• Number of employees

As with Method 3, above, the lender will calculate your income as the average net income from the most recent 12 to 24 months’ P&L statements. The advantage to providing more bank statements compared to Method #3 is that the lender may lift the 80% LTV cap or be more willing to approve marginal applications. 

Method 5: P&L only

This method doesn’t require bank statements at all. Instead, the lender estimates your income entirely from 12 months or 24 months of professionally-prepared profit and loss statements.

To qualify under a P&L-only program, you’ll need to provide the following:

At present, these P&L-only mortgages are typically capped at 80% of LTV. So you can expect to need a down payment of at least 20%, or to find an alternative source of funding for this amount.

Method 6: Bank statements plus licensed tax preparer certification of expense ratio

This bank statement loan method allows you to qualify for a bank statement mortgage with just 12-24 months’ bank statements and a letter from your licensed/certified tax preparer detailing your business overhead and expenses, plus some basic business plan information.

It can be a good option for business owners and self-employed individuals who don’t have 12-24 months of detailed P&L statements prepared, and who have low business expenses or expenses that can readily be proven to an accounting professional.

You’ll need to provide the following: 

The lender will look carefully at your bank statements to ensure that any recurring withdrawals are consistent with and accounted for in the stated expense ratio.

Under this method, your lender will subtract the expense ratio from your gross revenues each month and average them over the last 12 to 24 months. The result is the lender’s calculation of your income. 

Method 7: Variable expense ratio 

This is the method lenders will use if expenses are all over the map, or can’t be determined from existing documentation. This method may be a good match for an applicant with at least two years of business history, but who doesn’t have detailed P & L statements, or who doesn’t work with a CPA.

Under this method, the lender will estimate your business overhead based on the type of business and the number of employees. 

For product-based businesses, the lender will assume your expenses equal 50% of your gross revenues. For service businesses, the lender will generally calculate your expense ratio using a sliding scale based on the number of employees. Here’s an example from one of the lenders we frequently work with:

Under this method, you’ll also need to provide your most recent 12- or 24-months’ bank statements and a business plan or other documents detailing further information about your business.

The lender will look carefully at your bank statements to make sure withdrawals are consistent with the estimated expense ratio. If the bank statements indicate an expense ratio of more than 50%, the lender will use a different method or refer the application to a completely different loan program.

You may be asked to provide additional information, depending on what loan program your application gets referred to.

Why income trends matter in bank statement loan calculations

It’s important to be able to show some stability of income. Regardless of the method, the lenders will look at how your income trended over the last 12 to 24 months. If the trend is upwards, all is well. If your income has fallen, but it has stabilized recently, you may need to provide some additional information to the lender to demonstrate that your income will be stable from this point forward and is not likely to deteriorate further.

If your income has fallen, and the overall declining trend is continuing and has not shown signs of stabilizing, the lender may turn down your bank statement loan application (though you may still qualify under other programs, such as a ‘no ratio’ loan.

Integrating bank statements with other sources for loan calculation

Any of these methods may be combined with other income sources that are documented as Full Doc but not associated with self-employment. For example, you may be self-employed and use one of these methods to demonstrate income in addition to some W-2 or other verifiable income.

You may also have a co-applicant on the loan who has personal income tax returns, a W-2, and/or other more conventional forms of income verification. The lender will combine all the information to arrive at total verifiable income, or otherwise gain a fuller picture of your overall situation and your ability to support the loan. 

If you don’t have a CPA

If you don’t have a CPA or other tax preparer to help you with documentation, you can still potentially qualify for a mortgage. Many business owners we work with have plenty of income, but don’t regularly use a CPA or have months of detailed profit and loss statements at hand.

If you’re in this situation, some lenders are willing to forego the preparers’ statement. Instead, they’ll go through your bank statements and subtract the business’s withdrawals from the deposits each month. They’ll multiply the result by your ownership percentage in the business to estimate your pro rata income. 

Conclusion

Self-employed people and small business owners shouldn’t be discouraged when it comes to buying or refinancing a property. Whether you’re looking to buy or refinance an owner-occupied residence or acquire or refinance an investment property, it’s still quite possible for self-employed borrowers to qualify for a very competitive mortgage.

At DAK Mortgage, we specialize in self-employed borrowers, business owners, investors, non-U.S. citizens, and other situations needing lender flexibility and creative solutions.

If you’re self-employed, a business owner, emerging from bankruptcy or foreclosure, or you need an out-of-the-box lending solution, we’d like to work with you.

Please contact us at 321-239-2781 or [email protected] or by clicking here to learn more about these powerful and flexible lending programs designed especially for self-employed individuals.