A Declining Schedule C, a Rental Condo and a Deferred Student Loan
Dana applies for a conventional 30-year loan to buy a $450,000 townhome, putting 20% down ($360,000 loan). She has been self-employed as a graphic designer for four years. Schedule C net profit was $142,000 in 2022, $128,000 in 2023, and $96,000 in 2024; each year's net profit includes $18,000 of depreciation deductions. Her 2024 return shows gross receipts down 22% from 2023 because she lost her largest client in July 2024, and she has signed a new contract taking effect January 2025 that she says replaces that revenue. She also owns a rented condo: gross rent $2,400 per month; Schedule E net income was $8,400 (2022), $7,200 (2023) and $4,800 (2024), after $5,000 of depreciation each year. Monthly debts: car payment $465, and a student loan in deferment with a $42,000 balance and no payment amount on the credit report. Estimated PITI on the new loan is $2,780.
1. How should Dana's self-employment income be calculated, and how does the declining trend change the answer?
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Start with Schedule C net profit, not gross receipts, and add back non-cash deductions - the $18,000 of depreciation is real cash Dana keeps, so it counts.
The normal calculation averages the two most recent years of the adjusted figure. That gives ($128,000 + $96,000) ÷ 2 = $112,000, plus $18,000 depreciation = $130,000, or about $10,833 per month.
This file does not let you stop there. A 25% year-over-year drop plus a lost major client is a documented qualifying-income red flag, and the lender must obtain a written explanation in Dana's own words and then decide whether the income is stable. If the 2025 contract is signed, executed and independently verified, it supports using the higher trend. If it is a verbal promise, a proposal, or an unsigned draft, it supports nothing. In that case the conservative approach is to qualify on the 2024 figure: $96,000 + $18,000 = $114,000, or about $9,500 per month.
Also request a year-to-date profit-and-loss statement and current business bank statements. If receipts through the current quarter are running behind 2024, the file should be qualified at the lower number regardless of the new contract.
2. How should the rental condo income be treated, and what verification matters most?
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The condo has three years of Schedule E history, so the tax-return method applies and the two-of-three-year rule matters: use the most recent two years, and where the trend is downward, expect the lower year to govern.
The mechanics: Schedule E net income already reflects principal and interest, insurance, taxes and depreciation. Add back the $5,000 of depreciation, then subtract the principal portion of the mortgage payments, because principal is a real cash outflow that was never deducted. Using 2024: $4,800 + $5,000 = $9,800, minus roughly $3,600 of annual principal, or about $6,200 per year, roughly $517 per month. Averaging 2023 and 2024 would produce about $617 per month, but a 43% two-year decline in net rental income and declining rent justify using the lower year.
Verification matters more than the math here. Confirm the rent actually being received (lease, bank statements), confirm the property is not a second home disguised as a rental, and check that Dana has landlord experience and reserves for vacancies and repairs. If the property had fewer than two years of rental history or the income were not on the returns, the analysis would switch to a market-rent approach using a percentage of gross rents and subtracting the full housing payment - a materially less favorable result.
3. Using the numbers given, compute a rough debt-to-income ratio and say whether the file supports approval.
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Handle the student loan first. It is deferred with no payment on the credit report, so use the standard fallback of 1% of the outstanding balance: 1% × $42,000 = $420 per month. If Dana can produce a documented income-based repayment amount in writing, that figure can be used instead, but with a $42,000 balance the $420 is a fair working number.
Total monthly obligations: $2,780 PITI + $465 car + $420 student loan = $3,665.
Income scenarios:
- Higher self-employment figure (two-year average): $10,833 + $517 rent = $11,350 → DTI ≈ 32%.
- Conservative self-employment figure (2024 only): $9,500 + $517 = $10,017 → DTI ≈ 37%.
Neither number is close to a typical automated-underwriting ceiling, so on proportion alone the file looks approvable. The real risk is not the ratio; it is the documentation behind the numerator. A 20% down payment gives some cushion and helps reserves, but it does not cure an income trend that cannot be explained. The file should move forward only if the 2025 contract is verified or the year-to-date figures hold up; otherwise it is written at the conservative figure, where the deal still works. Explain the trade-off to Dana now rather than after the appraisal and title work are paid for.