Loan qualifications are by and large one of the most un-fun procedures we encounter during the home buying process. Endless lists of documents and requirements are enough to keep anybody up late at night, let alone those who don’t hold traditional employment.
Entrepreneurs and self-employed professionals are no strangers to the nightmare of income verification and tax returns typically required to get a foot in the door at the financier’s office. But that doesn’t mean you can’t get a home loan. Instead, it simply means you must look further afield to secure a non-traditional home loan, of which bank statement loans are one.
So what are bank statement loans, how do they work, and who are they for? This article will dive deep into the inner workings of a bank statement loan and discuss the pros and cons of obtaining one. Then we’ll talk about how you can qualify if you think it is the right choice for you.
What Is A Bank Statement Loan?
Bank statement loans are a type of home loan that self-employed borrowers can apply for rather than a traditional loan. Rather than producing tax return documents as income verification – which many self-employed professionals do not have – you can provide the last 12 months of bank statements to your lender as proof of income.
The concept has emerged as an innovative home loan solution for those with non-traditional employment to access the same home loan opportunities as anyone else. In particular, with the increase in self-employment and alternative employment options out there, bank statement loans are becoming increasingly popular.
Lenders and financiers consider bank statement loans to be risky since they’re non-qualified mortgages, meaning they’re not backed by Fannie Mae and Freddie Mac. This offers less overall cushioning to lenders and borrowers.
How Do Bank Statement Loans Work?
The application for a bank statement loan follows a different process than a conventional loan. Typically, you would produce two years of tax returns and a few months of bank statements, pay stubs, and W-2s when you apply for a loan.
Unlike conventional loans, a bank statement loan only requires two years of bank statements plus information about your business, such as statements of your profits and expenses. If you have personal and business bank statements, you will need to provide both during the application process.
Who May Be Eligible For A Bank Statement loan?
Bank statement loans are handy for individuals who do not receive a steady income or who are unable to produce proof of earnings from an employer. These individuals may fall under the following employment circumstances:
- Consultants
- Freelancers
- Entrepreneurs
- Small-business owners
- Real estate investors
It’s common for individuals in these professions to encounter challenges qualifying for an FHA loan since tax returns may be adjusted for deductions and business write-offs. On the other hand, bank statements can show your total earnings and cash flow.
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Advantages of a Bank Statement Loan
Obtaining a bank statement loan may be the difference between purchasing a home or not for some individuals with alternative employment. Even if you already own a home, bank statement loans can also be used to refinance a mortgage. Let’s dive deeper into the advantages of a bank statement loan.
Fewer Financial Records Are Required
It’s no news to anybody that qualifying for a conventional loan is becoming increasingly arduous. The conventional loan process requires borrowers to produce multiple financial documents to provide evidence of income and expenses in an effort to mitigate the lender’s risk.
Bank statement loan lenders acknowledge that not all borrowers can present these documents. You must still hit certain financial benchmarks to qualify, but no longer are you expected to jump through unreasonable hoops to purchase a home. The specific documents you will need to apply for a bank statement loan will vary from lender to lender.
Potential For Higher Loan Limits
Bank statement loans tend to offer greater flexibility, and one of these is a higher limit on your loan. Conventional loans are regulated by Fannie Mae and Freddie Mac guidelines which means that lenders have ceilings for the maximum loan value that can be allocated to a borrower.
Bank statement loans are not regulated by Fannie Mae and Freddie Mac. As a result, provided you can prove that you’re able to pay the loan back with minimal risk, your lender can approve a higher loan to get you into the home you truly want.
Higher Debt-to-Income Ratio May Be Accepted
Debt-to-income (DTI) ratio is a financial measurement used by banks and credit unions to determine the relationship between a borrower’s income and debt obligations. It ultimately helps to establish the burden of prospective debt on the borrower’s overall financial picture and, in turn, the risk factor associated with lending.
To work this out, divide your gross monthly income by monthly debt obligation. For example, say June earns an average of $4,000 per month and is being considered for a loan that would entail monthly mortgage payments of $1020. Let’s plug in those numbers:
1020 / 4000 = 0.26 = 26%
Assuming June has no other debt obligations, her DTI would be 26%. Lenders typically approve conventional loan applicants with a maximum DTI of 28% for a single loan, with no more than 36% with all debts considered. However, lenders often allow for a significantly higher DTI ratio – even up to 55% – for bank statement loan applicants. This means you may be able to purchase a bigger home with a bank statement loan.
Can Be Used For A Range Of Property Types
Many conventional mortgages restrict the type of real estate asset you can purchase with a loan. For example, you can only buy a primary residence with a VA or FHA loan. Bank statement loans do not apply the same property-type restrictions.
As a result, you can use your bank statement loan to purchase a primary residence, second homes, vacation and investment properties, and multi-family investments. This level of flexibility gives home hunters and real estate investors greater freedom to leverage their real estate assets than a conventional mortgage lender.
Disadvantages of a Bank Statement Loan
As with all real estate financing options, there are positives and downsides. Because bank statement home loans are not regulated under Fannie Mae and Freddie Mac directives, bank statement lenders are left to back their mortgages. In most circumstances, this involves a greater degree of potential risk for the lender, resulting in stricter borrower terms and upfront conditions.
The qualification process and specific terms will depend on your lender, but here are a few themes to consider as you make your decision.
Potential For Higher Interest Rates
While this depends on your overall financial situation, you may have to contend with higher interest rates than a conventional loan. You may also find that your bank statement loan comes with a prepayment penalty which could significantly increase the expense factor of refinancing if you have included this in your plans.
Larger Down Payments
Like interest rates, your borrower may insist on a higher down payment for you to qualify for a bank statement loan. This means that a borrower must have sufficient liquid cash reserves at the time of application.
Additionally, if a borrower cannot afford to front up with larger down payments, they may need to reapply later after saving some money. Alternatively, it may mean that you need to reconsider which home you purchase.
Not Offered By Every Lender
If a bank statement mortgage loan is starting to sound pretty good, it’s necessary to know that they are only offered by the best mortgage brokers. Not all financiers are prepared to undertake the risk associated with these types of loans. If you think a bank statement loan may be perfect for you, shop around to ensure you have the right lender to provide it.
What Are The Requirements For A Bank Statement Mortgage
While offering a couple of years of bank statements for mortgage loans is an excellent option for many self-employed entrepreneurs, you cannot qualify based on personal bank statements alone. Yes, tax return requirements are off the cards, but your finances must look in ship shape before you can apply.
Employment
To qualify for a bank statement mortgage, you don’t need to have traditionally structured employment. But you do have to provide proof that you have been self-employed for at least two years. In most cases, a letter from your accountant confirming that you have been in business for two years will suffice as evidence. You may also be able to supply a business license or website address.
If you have not been self-employed for the past two years, you may be required to reapply once you can provide evidence that you have been.
Credit Scores
Certain bank statement lenders offer bank statement mortgage loans to applicants with a credit score as low as 580. However, lenders may require applicants with low credit scores to pay higher down payments and increased rates for the loan’s term.
On the other hand, if you have a high credit score you’ll likely get better rates and terms for your loan. In many cases, this includes paying a lower down payment.
Down Payment
Some lenders will approve you with as little as 5% down, while others require a minimum of 20% down. In most cases, your down payment is influenced by your credit score. High credit scores indicate less risk for the lender, and lower down payments are permitted. On the flipside lower scores usually result in higher down payments.
Assets
You may need to provide proof of any liquid assets such as a 401k or any investments you have. Further, your assets must be fully verified. Generally, the more information you can provide, the more likely bank statement lenders are to approve you for the loan.
Property Requirement
Bank statement loans offer greater flexibility with the type of asset you want to purchase with your bank statement loan. You can access primary residences, second homes, vacation and investment property, and even multi-family investments with a bank statement loan.
Liquid Cash
You may need some liquid cash on hand to cover a few months’ mortgage payments. The exact amount will depend on the bank statement lenders, your employment, and the nature of your income. For example, if you’re seasonally paid and purchasing in the off-season, it’s a good idea to have cash reserves to tie you through your first few months of mortgage payments.
Alternatives To A Bank Statement Loan
Bank statement loans can be a lifesaver for entrepreneurs. But they are not the only type of loans available for self-employed borrowers. Here are a few other types of loans that you may qualify for:
- Conventional Loans – Conventional loans are offered by almost every mortgage lender, and they tend to offer more desirable terms and interest rates than bank statement loans. Even if you have alternative income sources, it may be worth checking with your mortgage lender to see if you qualify.
- DSCR Loans – A Debt Service Coverage Ratio mortgage helps property investors to qualify for a loan based on the profitability of the real estate they want to invest in rather than their financial records. While very few lenders offer this option, it may be a great alternative for professional real estate investors.
Final Thoughts
For self-employed borrowers, getting approved for a home loan has long been a challenging feat. With financial products like bank statement loans now available, it’s easier than ever for individuals without traditional employment to qualify for a mortgage.
Bank statement lenders require borrowers to meet eligibility benchmarks such as minimum credit scores, details of personal and business accounts, or minimum down payment amounts. Without these, individuals may have limited borrowing capacity.
If you are an entrepreneur or professional real estate investor interested in securing a bank statement loan for your next real estate venture, get in touch with The Mortgage Shop today. We offer out-of-the-box financial solutions to help self-employed borrowers secure their dream property and can help you find a tailored mortgage program perfectly suited to your financial situation.
