Self-Employed Income and DTI With Rental and Support Obligations
Marcus applies for a $540,000 conventional purchase loan. He owns 100% of an S-corporation and files jointly. His 2024 W-2 wages from the S-corp are $72,000; the K-1 shows ordinary business income of $118,000 and distributions of $25,000. The 2024 corporate return deducts $22,000 depreciation. His 2023 W-2 wages were $68,000, the 2023 K-1 ordinary income was $96,000, and 2023 depreciation was $18,000. He also receives $1,900 per month gross rent from a duplex; Schedule E shows $6,800 annual expenses and $9,500 depreciation. Proposed PITI is $3,780; he has a $650 auto payment, a $240 student loan payment on a 10-year amortization, and $1,200 per month child support with more than 10 months remaining. Credit score is 704. The AUS returns an Approve/Eligible finding. The processor wants to use only the 2024 K-1 income because it is higher.
1. Calculate Marcus's stable monthly qualifying income. Show your treatment of the S-corp income, distributions, depreciation, and rental income.
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Start with the S-corp income. For 2024, add W-2 wages of $72,000, K-1 ordinary income of $118,000, and depreciation of $22,000, for $212,000. Distributions are not added again because they are a distribution of already-taxed business income. For 2023, add $68,000 wages, $96,000 K-1 income, and $18,000 depreciation, for $182,000. The two-year average is $197,000, or $16,416.67 per month. Using only 2024 is not appropriate without a documented analysis supporting a stable or increasing trend; the safer calculation is the two-year average. For the duplex, add back non-cash depreciation to Schedule E: $1,900 x 12 = $22,800 gross rent, minus $6,800 operating expenses = $16,000 net cash flow. Apply the 75% factor for a 2-unit property: $12,000 per year, or $1,000 per month. Total qualifying income is about $17,416.67 per month.
2. Using that income, calculate the DTI and assess whether the file supports a reasonable ability-to-repay conclusion.
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Total monthly debts are PITI of $3,780 + auto $650 + student loan $240 + child support $1,200 = $5,870. DTI is $5,870 / $17,416.67 = 33.7%. That is below the 43% threshold often used as a benchmark, and the AUS finding is Approve/Eligible. But DTI alone does not establish ATR. The lender must verify income, assets, employment, credit, and the mortgage terms, and must consider residual income and payment shock. The student loan is counted at the fully amortizing payment because it is on a 10-year schedule. Child support is counted because more than 10 months remain. The file looks supportable, but the lender should document the self-employed income trend and not simply select the higher year.
3. What documentation or analysis should the processor obtain before finalizing income?
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The processor should obtain the 2023 and 2024 personal and corporate returns, all K-1s, W-2s, and year-to-date financial statements if the loan closes more than a few months into 2025. The underwriter should analyze the S-corp's viability, declining or increasing trends, and whether distributions were needed for liquidity. Depreciation can be added back as a non-cash expense, but only after confirming it is bona fide. Rental income requires the lease, Schedule E, and evidence of receipt; the 75% factor applies to the net cash flow. The processor should also document the child support obligation and student loan terms. If the 2024 income is materially higher, the lender may need a written justification supported by the trend, not just choose the favorable year.