When a self employed borrower applies for a loan modification the lender will document the request in a similar manner compared to someone not self employed. An underwriter will review current monthly income and attempt to establish a lower rate that will provide a more affordable payment. The lender will use a standard debt to income ratio of around 38 percent to establish the new, modified rate.
For someone who receives a paycheck from their employer and has a consistent gross monthly income the underwriter has a relatively easy job when calculating debt ratios. For the self employed who do not receive a consistent paycheck on the 15th and 30th of every month, another method of determining income for the self employed is, um, employed.
The lender will ask for a year to date profit and loss statement listing income and expenses. This statement can be prepared by the borrower. If the profit and loss statement reflects a net income of $50,000 from January 1 through October 31, the lender will divide $50,000 by the number of months on the profit and loss statement, in this example, 10. The income used for this self employed borrower is then $5,000 per month. Yet the underwriter will want to see some evidence of receiving the $50,000 for the past 10 months. This is completed by providing bank statements from the previous two months showing income supporting the $5,000 per month amount.
Verifying income from the self employed borrower combines verified income with a little common sense. Yeah, I know. When do lenders exhibit common sense? And I’d agree with you in that common sense is sometimes a rare commodity. But when establishing debt ratios for the self employed, lenders follow these guidelines.