What to watch for when lenders calculate income
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By Scott Sheldon  May 2, 2014 12:00 am

Since the inception of qualified mortgages this year, the process to successfully close on a mortgage has been compliant-heavy by industry standards. Such is especially true if you own your business. 

It’s no mystery there is a general consensus amongst business owner consumers that banks do not make the ability to qualify easy for the entrepreneur. 

Here’s what to expect or what you need to attain an approval:

• Two Tax returns: Plan on providing your lender the most recent two years of federal tax returns. Two years of tax returns is the industry norm with most banks and lenders, or a copy of the most recent year’s filed IRS extension, if not yet completed. When supplying tax returns, it’s crucial to be aware of the fact it’s IRS-validated tax returns that will be used for income calculation purposes. 

If the tax return is filed, but not validated by the IRS, in most cases, your loan will be held up until IRS actually signs it off.

Expect lenders to average your income over the most recent last 24 months (despite a good or a bad year). In most cases, you’ll be hard-pressed to have a lender ignore a tax return in light of the more favorable year’s higher income figures.

Applying for a mortgage loan now? You’ll need to provide 2011 returns, 2012 returns and a copy of the IRS-filed 2013 extension. Let’s say your income in 2011 is low; lenders will still use this income if they have not received the validated 2013 return. When the 2013 return validation comes in, 2011 can be omitted from the picture as 2013 and 2012 validated returns meet the two-year threshold.


• Year-to-date profit and loss statement: A year-to-date profit and loss statement supports the continuance of income, especially in the circumstance of one year’s income being higher or lower than the other. Let’s say 2012’s income was more than 2013, lender is going to request a 30-day profit and loss statement to support your current income. This action addresses any possible concerns about declining income, which is a risk characteristic lenders look for when making a sound loan approval.


• Business funds: If any of the funds used for the loan – whether they be cash to close, down payment or reserves (money in savings) – are primarily used in connection with the operation of your business, more scrutiny will apply. Here’s why: a reasonable assessment could be made that repositioning funds out of the business for use in another endeavor (like procuring a home loan) could impact the future viability of that business. Moreover, the sustainability of the revenue the business generates. 

Providing a third-party validation about the use of these 

‘Sheldon,’ see page 14


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funds omits the risk test. This can be accomplished by a bookkeeper or accountant simply validating that the use of business funds shouldn’t impact the viability of the business. 

• Calculating the income: Expect a 24-month average if your business has been in existence for the past 24 months. Lending caveat – if your business has only been in existence for the most recent last 12 months, you can still potentially qualify for a mortgage without the two years returns. You will need six months of self-employment income identified on a validated tax return in order to use income short of two years.

Lenders use the following when calculating a self-employed consumer’s income: net profit; business use of the home (if applicable); depletion; and depreciation.

How it all comes together:

1. Take net income. 

2. Add back business use of the home. 

3. Add back depletion.

4. Add back depreciation.


Do this for each year’s income tax return and simply divide by 24. This is the average income lenders will use when qualifying you for a mortgage. It doesn’t matter whether you’re purchasing a home or refinancing a home, calculation is computed the same.

Additionally, self-employed borrowers showing strong home-equity, excellent credit, millions of dollars in the bank, further supporting creditworthiness will not offset the need to show income. In this compliant, focused world of home lending, income is and remains king.


Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.

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