Self-Employed S-Corporation Income and DTI
Luis Ortega is the 100% owner of an S-corporation that installs commercial flooring. He applies for a $450,000 cash-out refinance on his primary residence. The loan file shows 2024 W-2 wages of $60,000 from the S-corporation and a 2024 Schedule K-1 with $48,000 of ordinary business income. The K-1 includes a $12,000 gain from the sale of a used truck and $6,000 of depreciation. The corporation's gross receipts were $820,000 in 2022, $740,000 in 2023, and $655,000 in 2024. The loan officer also finds $18,000 of business bank account transfers to Luis in 2024 that were not reported on the K-1. Proposed housing payment is $3,200; monthly debts are $450 car, $250 student loan, and $200 credit card. Luis has $55,000 in retirement reserves and a 720 score. The lender's guideline allows 45% DTI with compensating factors.
1. Calculate Luis's qualifying monthly income. Explain each adjustment to the K-1 income and whether the $18,000 of transfers counts.
Read the worked answer
Start with the W-2 wages: $60,000. Add the K-1 ordinary business income of $48,000, but remove the $12,000 truck-sale gain because it is nonrecurring. Add back $6,000 of depreciation because it is a non-cash expense. Adjusted K-1 income is $48,000 − $12,000 + $6,000 = $42,000. Total qualifying income is $60,000 + $42,000 = $102,000 per year, or $8,500 per month. The $18,000 of bank transfers is not added: for an S-corp owner, distributions are not separate qualifying income, and the transfers may already reflect taxed business profit. Without a documented, recurring source and tax reporting, they cannot be used. The loan officer should obtain the corporate return, K-1, and business bank statements to verify.
2. The business's gross receipts have declined about 10–11% annually. How should the loan officer address this, and what documentation is needed?
Read the worked answer
The 2022-to-2024 decline is $820,000 to $655,000, about 20.1%, with declines in both years. That is material. The loan officer should obtain a written explanation, the 2025 year-to-date profit-and-loss statement, business bank statements, and the corporate tax returns. The underwriter should determine whether the decline is temporary or continuing. If the most recent year is lower, many guidelines require using the lower of the most recent year or a two-year average, and may require a CPA letter or additional reserves. A continuing decline could disqualify the income or the loan; the $18,000 transfers do not cure it. The file should document the analysis, not just average the three years.
3. Using the income from the first task, what is the DTI, and does Luis meet the 45% guideline? What compensating factors could matter?
Read the worked answer
Total monthly debts are $3,200 + $450 + $250 + $200 = $4,100. DTI is $4,100 ÷ $8,500 = 48.2%. That exceeds the 45% guideline by 3.2 percentage points. Reserves of $55,000 equal about 17 months of the $3,200 housing payment, and a 720 score helps, but those are not enough by themselves if the guideline is a hard 45%. Paying off the $200 credit card would reduce DTI to $3,900 ÷ $8,500 = 45.9%, still above 45%. The loan officer should not recharacterize distributions or use the truck gain to force the DTI down. Options include a smaller loan amount, a documented income increase, or a lender exception with strong compensating factors.