Qualifying income calculation when using business bank statements
General Requirements for Business Bank Statement Qualification
Qualifying income calculation when using business bank statements begins with verifying that the borrower meets the required documentation, ownership, and business history standards. To be eligible for the business bank statement program, the borrower must demonstrate legitimate business ownership, provide the necessary statements, and show a consistent operating history that supports the income being used for qualification.
- Documentation Period: The borrower must provide 12 or 24 consecutive months of business bank statements.
- Borrower Ownership: The borrower is considered self-employed if they have an ownership interest of 25% or greater in the business. However, specific programs, such as the River Series Business Bank Statement option, require a minimum 50% ownership. The ownership percentage must be verified by a third-party document, such as an Operating Agreement or a CPA/Tax Preparer letter.
- Business History: The borrower must generally have been self-employed in the same business for a minimum of two years.
- Unacceptable Accounts/Activity: Deposits derived from passive or portfolio sources, such as day trading, real estate investors with fewer than 5 residential units, or distributions from limited partnerships, are generally ineligible. Nonprofit business entities are also ineligible.
Income Calculation Methods (Applying the Expense Factor)
Since business bank statements reflect gross deposits, we must apply an “expense ratio” or “expense factor” to the gross revenue to determine the borrower’s actual net qualifying income. The income calculation is then multiplied by the borrower’s percentage of ownership.
Lenders typically utilize one of three calculation methods:
Option 1: Fixed Income Expense Ratio (Uniform Expense Factor)
This is the most straightforward method, where a standardized expense rate is applied based on the business type.
- Standard Ratio: A 50% expense ratio is typically utilized for most business types.
- Income Formula: Qualifying Income is the average of eligible deposits over the 12 or 24 months, multiplied by 50%, and then multiplied by the borrower’s ownership percentage.
- Service Business Ratios (Edge/Sharp Series): Some programs allow for lower fixed ratios for small, specific service businesses:
- 30% Expense Factor is eligible for small service businesses with no more than 5 employees and rent not exceeding 15% of gross income.
- 20% Expense Factor is eligible only if the borrower is the sole owner and operator of the business, it is a service business (no heavy equipment or cost of goods), and it does not incur office rent.
Option 2: Third-Party Prepared Profit & Loss (P&L) Statement
If a fixed ratio is not used, the borrower can rely on a statement prepared by a licensed professional.
- Required Preparation: The P&L statement must be prepared by a Certified Public Accountant (CPA), Enrolled Agent (EA), or licensed tax preparer (PTIN/CTEC).
- Required Attestation: For some programs, the professional preparing the P&L must attest to having filed the borrower’s most recent business tax returns.
- Income Calculation: Qualifying income is the monthly net income from the P&L multiplied by the borrower’s ownership percentage.
- Validation: The P&L statement is cross-referenced with the bank statements. Eligible deposits on the bank statements must generally support the gross revenues listed on the P&L statement, typically requiring deposits to be within a specific tolerance, such as 15% of the gross revenues or at least 85% of gross receipts (River Series).
Option 3: CPA/Tax Preparer Expense Ratio Letter
Instead of a full P&L, a letter specifying the exact ratio can be used.
- Documentation: A signed statement from a third-party tax preparer is provided, indicating the business’s specific expense ratio based on the most recent year’s tax returns.
- Minimum Ratio: The minimum allowable expense ratio for qualifying is 10%, though some programs enforce a minimum expense level of 20% for the P&L or expense ratio.
Underwriting and Verification Factors
Regardless of the option chosen, the underwriter reviews several key factors to ensure the calculated income is accurate and stable:
- Qualifying Limit: The calculated income is compared against the income listed on the initial signed loan application (1003). The lower of the calculated average and the stated income is used for qualifying.
- Treatment of Declining Income: If the trend of eligible deposits is declining by more than a certain threshold (e.g., 25% decrease in the most recent three months vs. total deposits, or a 10% decline year-over-year in the Connect series), an explanation (LOE) may be required. If the decline is significant, the loan may be deemed ineligible or the income calculation must be based on the most recent 12 months rather than the full 24-month period.
- Co-mingled Accounts: If a single account reflects both personal and business expenses, it is considered a co-mingled account and is treated as a business bank statement for qualification purposes, requiring an expense ratio deduction.
- Large Deposits: Unusually large deposits that represent greater than 50% of the average monthly deposits may require a Letter of Explanation (LOE) to confirm they are business-related and not non-recurring income (like tax refunds or loan proceeds). If the LOE is sufficient, additional sourcing may not be required.
- Non-Cash Add-Backs: When calculating income based on a P&L, non-cash expenses such as depreciation, depletion, and amortization/casualty losses may be added back to the net income for qualification.
- Tax Documentation: Tax transcripts (IRS Form 4506-C) are generally not required for Bank Statement loans. However, if tax returns and/or transcripts are provided in the loan file, the loan is rendered ineligible for the Bank Statement Product and must be underwritten as a Full Documentation loan.
FAQ's
Ineligible deposits that must be excluded from the analysis include, but are not limited to, transfers between borrower bank accounts (except business to personal), tax refunds, payroll deposits from other income sources, advances, loan proceeds, and unexplained large deposits. Unusually large deposits exceeding 50% of the average monthly deposits may require a Letter of Explanation (LOE) or may be excluded.
If the account reflects both personal and business expenses, it is considered a co-mingled account. These accounts will be qualified as a business bank statement loan and must adhere to the rules and expense factors used for business accounts.
If the trend in eligible deposits is declining significantly (e.g., a 25% or more decrease in the most recent three months vs. total eligible deposits), a satisfactory Letter of Explanation (LOE) is required. If the decline is substantial year-over-year (e.g., greater than 10%), the income calculation may be restricted to the most recent 12 months of eligible deposits, rather than the full 24 months, or the account may be deemed ineligible.
The monthly net income from the P&L statement is multiplied by the borrower’s ownership percentage. This income is used, provided the eligible deposits in the bank statements support the gross revenues listed on the P&L within an acceptable tolerance, such as 15% of the gross revenues.
Yes, the minimum allowed expense ratio for qualifying income using a CPA/Tax Preparer statement is typically 20%. Some programs set a 10% floor for the expense ratio when a third-party statement is used.
Yes, a signed statement from a third-party tax preparer (CPA/EA/PTIN) can be provided, indicating the specific expense ratio of the business based on the most recent year’s tax returns.
The calculation uses the average of eligible deposits (over 12 or 24 months) × (1 minus the expense ratio) × ownership percentage. The lowest resulting income is then compared to the income disclosed on the initial signed loan application (1003) and the lower figure is used.
Some programs permit a lower expense factor, such as 30% for eligible small service businesses (like consulting, accounting, or legal) with no more than five employees and low rent. A 20% expense factor may be available if the borrower is the sole owner and operator of a service business with no costs of goods or heavy equipment.
The standard fixed expense ratio utilized for most business types is 50%.
The lender must apply an expense ratio to the total eligible gross deposits over the required period (typically 12 or 24 months) to determine the net qualifying income for the borrower. This net income is then multiplied by the borrower’s ownership percentage.
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