Whether you are self-employed, a freelancer or have a variable income stream, you’ll face special challenges getting a typical mortgage and may need to apply for a bank statement loan. What is a bank statement loan, and how do these loans work?
What is a bank statement loan?
A bank statement loan is a product that enables the self-employed and those without a stable monthly income to obtain financing for a home.
Typical mortgages require you to provide documentation of employment history, several months’ pay statements and a letter from your employer as well as W-2s and several years of tax returns. But the self-employed person and others whose income varies month to month will be unable to provide much of this documentation and may have business expense write-offs that make income calculations tricky. To serve these borrowers, some financial institutions make bank statement loans based on documents showing what the self-employed borrower earns from his business.
Bank statement loans differ from typical mortgages in important ways. With typical loans, called qualified mortgages, the lender must make a good faith determination of your capability to pay off the loan. This is known as the ability-to-repay rule. Bank statement loans are not considered qualified mortgages, which means lenders use their own, more flexible standards to determine whether you can pay off the loan. Those standards vary by lender. Also, bank statement loans typically have a higher interest rate than those made to typical borrowers. The rate may be a half-point to a full point higher.
As with typical mortgages, lenders offer both adjustable rate and conventional bank statement loans.
How to obtain a loan
If you are the borrower in this situation, you may be asked to provide one to two years of bank statements. If you use a personal bank account for business income and expenses, the lender will evaluate records from it. If you keep your business accounts separate from personal, you’ll be asked for statements from both. You may also be required to supply profit-and-loss statements prepared by a licensed tax professional. Even if you are not asked for these, supplying them may bolster your case. Generally bank statement lenders do not require applicants to provide copies of tax returns.
Because bank statement loan standards vary from institution to institution, it’s a good idea to apply to multiple lenders. Lenders will evaluate your records and average 12 months of your income to find your average monthly gross income and determine your ability to pay. Because your income as a self-employed person may fluctuate, some lenders may require you to have cash reserves on hand at closing that are sufficient to cover three to six months of housing expenses. These expenses include not just your house payment but also applicable property taxes, homeowners’ insurance payments and other related expenses.
As with a regular mortgage, your lender will consider your credit score. Depending on what it is, the lender may tighten or loosen the debt-to-income and loan-to-value ratios. A strong credit score in the 700s may allow you to put down only 10 percent of the purchase price, whereas a poor credit score may require you to make a relatively larger down payment.
Related – FAQs on Financing Your First Home