Declining Self-Employment Income and Unsupported Funds
A self-employed borrower applies for a $380,000 purchase loan. Federal tax returns show net income of $180,000 in 2022, $150,000 in 2023, and $120,000 in 2024. Year-to-date 2025 net income is $80,000, and business bank statements show deposits down about 20% from the same period last year. The borrower wants the broker to "use the 2022 number because that was my best year." A $50,000 deposit appeared in the personal account two months ago; the borrower says it was from selling a car but has no bill of sale. The borrower also has a $25,000 gift from her parents for closing costs. The appraisal comes in $15,000 below the purchase price.
1. How should the broker approach qualifying income, and can the 2022 figure be used? Explain.
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The broker should not use 2022 alone. Self-employment income is analyzed using the most recent two years and the year-to-date figures, with attention to trends. The file shows $180,000, then $150,000, then $120,000, and 2025 deposits are down another 20%. A reasonable starting range is the lower of the two-year average or the most recent year, but the declining trend may require using the $120,000 figure or even less, depending on the lender's analysis and the 2025 results.
The broker may present the 2022 figure as history, but cannot select it merely because it produces the best result. The borrower should be told that the lender will review the trend, may request a profit-and-loss statement, business bank statements, or a year-to-date verification, and may decline or reduce the loan if the decline is not explained. The broker should document the income calculation and the borrower's explanation, but should not submit misleading figures.
2. What must be done about the $50,000 deposit and the $25,000 gift before closing?
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The $50,000 deposit is a large deposit that must be sourced. The borrower's statement that it came from selling a car is not enough without documentation. The broker should request a bill of sale, title transfer, or other evidence, plus evidence that the funds moved into the account. If the source cannot be documented, the funds should be excluded from the assets available for closing rather than treated as verified.
The $25,000 gift also needs documentation: a signed gift letter stating the donor, amount, and that repayment is not required; evidence of the transfer from the parents' account; and a bank statement showing the parents had the funds. The broker should confirm whether the gift is acceptable for the down payment, closing costs, or reserves under the loan program. The broker should not accept the gift as cash without a paper trail or encourage the borrower to season the funds artificially.
3. How does the low appraisal affect the transaction, and what options should the broker present?
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A $15,000 shortfall means the loan-to-value ratio rises if the price stays the same. The borrower may need to bring additional cash, reduce the loan amount, or accept mortgage insurance if the program requires it. The broker should recalculate the LTV and show the borrower the revised loan amount, cash to close, and any pricing change.
The broker can also present options such as renegotiating the purchase price with the seller, requesting a reconsideration of value with additional comparable sales, or using a different loan structure if eligible. The broker should not pressure the appraiser to change the value or suggest that the borrower misrepresent the contract. Any appraisal challenge should be based on documented market evidence and handled through the lender's process. The borrower should understand the new numbers before the closing date is confirmed.