Self-Employed Borrower, Declining Deposits
Priya, a loan originator, is prequalifying Dev, a sole proprietor who files Schedule C. Dev reports 2023 net profit of $92,000 and 2024 net profit of $61,000 on his returns. His bank statements show average monthly deposits of $18,500, but his Schedule C gross receipts are $210,000 (2024) and $240,000 (2023). Dev wants to qualify for a $520,000 purchase with 10% down. His credit score is 712, and he has $95,000 in liquid assets. Priya's processor says 'use the bank statements - the deposits look great.' Dev mentions he 'sometimes deposits business revenue into a personal account' and has a $40,000 owner draw he took in 2024 that is not on the P&L.
1. Which income figure should be used to qualify Dev, and why can't the bank-statement deposits be used as stated?
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For a sole proprietor, qualifying income is derived from the Schedule C net profit, adjusted for non-cash items and non-recurring items. The two-year average is ($92,000 + $61,000) / 2 = $76,500. Declining income must be analyzed: the 2024 figure ($61,000) is materially lower than 2023, so an underwriter may use the lower year or require explanation for the decline.
Bank-statement deposits ($18,500/month = $222,000/year) cannot be used as income because:
- They represent gross receipts, not net profit - business expenses are not deducted.
- Dev admits commingling personal and business funds, so deposits are not a reliable income measure.
- The $40,000 owner draw is a distribution of profit already reflected (or not) in the Schedule C; it is not additional income and cannot be double-counted.
The processor's 'use the bank statements' approach is a classic error - it inflates income and creates fraud/repurchase risk.
2. Using the $76,500 figure, does Dev appear to qualify? Show a rough debt-to-income check, stating assumptions.
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Assumptions: 30-year fixed, 6.5% note rate, P&I on $468,000 loan (90% of $520,000).
Monthly P&I ≈ $468,000 × (0.065/12) / (1 − (1 + 0.065/12)^−360) ≈ $2,958. Add estimated taxes/insurance/HOA ≈ $650 → total housing ≈ $3,608. Assume no other debt (Dev stated none).
Monthly qualifying income = $76,500 / 12 = $6,375. DTI = $3,608 / $6,375 ≈ 56.6%.
Most conventional programs cap at 45–50% (with compensating factors sometimes 50%). At ~57%, Dev likely does not qualify on the Schedule C average. Using the lower 2024 year ($61,000 = $5,083/month) yields ~71% DTI - clearly out.
Conclusion: Dev is short. Options: larger down payment, lower purchase price, co-borrower, or a documented non-QM bank-statement program (which would require clean business bank statements and a formal 12–24 month analysis, not the commingled personal account).
3. What red flags must Priya document, and what is her ethical obligation regarding the processor's suggestion?
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Red flags to document:
- Commingled funds - business revenue in a personal account undermines any deposit-based analysis.
- Declining Schedule C income - 2023 to 2024 dropped ~34%; must be explained and may force use of the lower year.
- Undocumented $40,000 owner draw - not on the P&L; could indicate unreported income or a loan disguised as a draw.
- Processor pressure - 'use the bank statements' is an instruction to use an inappropriate income source.
Ethical obligation: Priya must not adopt the processor's suggestion. Using gross deposits as income would misrepresent Dev's ability to repay, violating TILA/ATR standards and the originator's duty of candor. She should:
- Document the commingling and declining income in the file;
- Require a formal profit-and-loss and business bank statements if a non-QM program is pursued;
- Escalate the processor's instruction to compliance;
- Communicate honestly with Dev about the shortfall rather than promising approval.