Bank Statement Mortgage Loans
What is a bank statement loan?
A bank statement loan is a special type of mortgage that lets you apply without having to show your income on W2 forms, tax returns, and pay stubs. Instead, you simply show 12 to 24 months of bank statements to the lender as proof of your income. If you have trouble getting approved for a mortgage due to heavy tax write offs you take on your small business that make your income look very small, then a bank statement loan might be a good option. There's no magic here, so expect the lender to comb through your bank statements very carefully and bring up questions and issues they find.
A bank statement loan is great for self employed borrowers that write off expenses
If you run a small business or are self employed, you probably try to reduce your tax liability as much as possible by writing off expenses, tracking your mileage, and making business-use purchases throughout the year to reduce your taxable income. These tax-savvy business activities can be a double-edge sword when trying to qualify for a mortgage because lenders are looking at your income to determine if you're capable of paying the mortgage. If your taxable income is too low, then you can't get approved for a mortgage.
The good news is a bank statement loan is geared towards self-employed borrowers and small business owners and can make the difference in getting approved for a mortgage. Often, self employed individuals and small business owners have much greater financial strength than their taxable income reported to the IRS shows. For example, you may be writing off depreciation on equipment or a business-use vehicle and that depreciation write-off effectively lowers your reported income to the IRS. Lenders that offer bank-statement loans recognize these tax deduction techniques and are willing to look at your financial profile from a bigger picture.
Also, if you're self employed and can get approved for a traditional mortgage, it probably makes more sense to go with the traditional mortgage because bank statement loans generally have higher costs/rates than traditional mortgages.]
Pros and Cons
Pros of bank statement loans
- No tax returns needed: Traditional mortgages require tax returns, W2 forms, and pay stubs. With bank statement loans the lender is mainly looking at your bank statements to determine your income. This is well-suited for self employed borrowers.
- Less than perfect credit scores accepted: With some lenders, you can have a credit score as low as 600 and still qualify. Keep in mind, however, that you'll typically need a bigger downpayment if your credit score is low.
- High loan limits: Since bank statement loans are not "conforming loans" backed by Freddie Mac or Fannie Mae, the loan limits are up to the lender.
- Can be used for investment properties and second homes: You can use a bank statement loan for investment property purchases or a second home. It doesn't have to be used for your primary residence.
Cons of bank statement loans
- Usually higher rates: Because bank statement loans have more risk associated with them, lenders typically charge a higher interest rate.
- Higher down payment required: You'll often need at least a 10% down payment on a bank statement loan, and 20% if you want better rate terms.
- Prepayment penalties: Some bank statement loans have prepayment penalties where you can be charged if you refinance or pay off your loan too early.
What is an "expense factor" on a bank statement loan?
An expense factor is the percentage of your bank statement deposits that the lender will deduct as expenses when they are estimating your qualifying net income. For example, if your expense factor is 50%, and your average monthly bank statement deposits is $50,000, then your net income is $25,000 for the purposes of applying for a mortgage.
A Licensed CPA/tax preparer letter may be required
Most lenders that offer the bank statement loan will require that you have an independent licensed CPA or tax preparer write a letter stating that they've reviewed the last two years of your business tax returns. The CPA letter will need to contain the following things:
If self-employed (not a business owner)
- The CPA confirms that client is a 1099/ Schedule C non-business owner
- The CPA confirms that client has been self employed for more than 2 years
- The CPA confirms the clients actual expense factor
If a business owner
- The CPA confirms the clients ownership percentage of the business
- The CPA confirms that the business has been operating for at least 2 years
- The CPA confirms the expense factor of the business
- If business funds will be used for the purchase (e.g., for a down payment), CPA needs to write something to the effect stating that the funds withdrawal from the business will not negatively impact the business.
Should I get a bank statement loan or a traditional mortgage?
As a self-employed individual or small business owner, you have a couple strategies in getting approved for a mortgage: (1) you can report a higher income to the IRS so that you have the tax returns showing the lender that you're making enough income to afford a mortgage payment, or (2) you can apply for a bank statement loan (or other Non-QM mortgage product) and get approved based on your cashflows as shown in your bank statements.
Applying for a traditional mortgage
Many small business owners don't qualify for a traditional mortgage (i.e., a mortgage backed by Fannie Mae or Freddie Mac) because their reported income on their tax returns is too low, due to lots of tax write-offs they take advantage of. In order to get approved in a traditional mortgage, they have to make fewer tax writeoffs and bite the bullet with Uncle Sam and pay more taxes on their next tax return. This strategy has some drawbacks: 1) the increased tax burden that you have to pay, and 2) the delay in waiting a full tax year before you can report your taxes. You have to do the calculation and see if paying the additional taxes is worth the savings you might get with a lower rate through a traditional mortgage. You also have to consider the opportunity cost of postponing your home purchase until after the tax season. If you think housing prices will continue to rise, then you have to consider whether waiting on a potentially-lower rate with a traditional mortgage will be a better option versus getting a bank statement loan now. Remember, bank statement loans typically have a higher interest rate than a traditional mortgage, but not always.
Applying for a bank statement mortgage loan
If you're self-employed or a small-business owner, and can't get approved for a traditional Fannie Mae/Freddie Mac mortgage due to a low reported income on your tax returns, you can apply for a bank statement loan. Lenders won't even look at your tax returns on a bank statement loan. Instead, they'll analyze your bank statement activity over a 12-month (or 24 month) period to derive your average monthly income, based on banking deposits and an expense factor. The benefit of getting a bank statement mortgage is that (a) you can continue to use tax writeoffs and keep your reported income low on your tax returns, and (b) you don't have to delay your home purchase plans as you would in the traditional mortgage scenario above. The drawbacks to a bank statement loan are that you may get a higher interest rate and you will usually need 10% or more as a down payment. However, these tradeoffs can often be worthwhile when considering how much additional tax you'd have to pay Uncle Sam in order to get approved for a conventional mortgage.Bank statement loans are considered "Non-QM" ("Non Qualified Mortgage")
The term "Non-QM" literally means "non Qualified Mortgage". A qualified mortgage is a technical term and describes a mortgage that satisfies the criteria to be backed by Fannie Mae and Freddie Mac. So a non-Qualified mortgage is any mortgage that can't be backed by these large government sponsored entities.