The Self-Employed Borrower's Declining Income
Marcus applies for a $385,000 refinance. He has owned a landscaping LLC for six years and files a Schedule C. His 2023 return shows net profit of $96,000; 2024 shows $61,000. His 2025 year-to-date profit-and-loss statement (prepared by his CPA, not audited) projects $48,000 annualized. He also took a $22,000 owner draw in 2024 that his accountant classified as a distribution of retained earnings, not wages. The loan officer wants to average the three years to maximize qualifying income and tells Marcus the declining trend 'won't matter because we're averaging.' Marcus's middle credit score is 704, and he is putting 25% down on the refinance.
1. How should qualifying income be analyzed, and is the loan officer's averaging approach defensible?
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Averaging is not automatically wrong, but it cannot be used to paper over a clear decline. For self-employed borrowers, the analysis must (1) use the business's net income after adjustments (adding back non-cash items like depreciation, subtracting non-deductible items), and (2) evaluate the trend. A three-year average of $96,000 / $61,000 / $48,000 is about $68,333 - but the trend is consistently downward, and the most recent figure is a projection from an unaudited P&L, which is weaker evidence than a filed return.
The defensible approach: weight the most recent completed return (2024, $61,000) most heavily, treat the 2025 P&L as supporting documentation rather than a substitute, and document a written justification if the lender chooses to use an average. A two-year average of 2023–2024 ($78,500) may be permissible where the decline is explained and stable, but a lender relying on a projected $48,000 to support a higher average is exposed. The correct answer is to qualify conservatively - likely using something closer to the 2024 figure - and to flag the trend in the file.
2. Does the $22,000 owner draw count as qualifying income?
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No. An owner draw that is a distribution of retained earnings is not wages and is not added to the borrower's qualifying income. It is already reflected inside the business's net profit figure; adding it again would double-count. Only if the draw were documented as W-2 wages paid through payroll (and deducted as a business expense) would it be treated as employment income - and then it would already be excluded from the Schedule C net profit, so it could be added back once. The accountant's classification controls, and the loan officer should not treat the draw as a separate income stream.