Bank statement mortgages are becoming more common, loans where monthly bank statements can be used instead of tax returns to support a mortgage application.
There is new evidence that bank statements can lead to better credit scores for many borrowers, especially those with lower credit scores. In turn, better credit scores can mean reduced mortgage rates and more likely mortgage approvals.
Credit Scores and Bank Statements
There has been a lot of recent interest in bank statements. One reason is that such statements can show how borrowers use cash, how much they take in, and how much goes out.
It’s not just lenders who see a growing value in bank statements. The same is also true with credit scoring systems. With consumer approval, both UltraFICO™ Score and Experian Boost use bank activity to better understand consumer credit usage.
Experian said that after looking at bank statements two out of three credit scores improved. Most importantly, consumers with marginal credit scores saw significant improvements.
“For consumers with a score below 680, 75% saw an improvement in their credit score,” it said. Experian added that “depending on credit tier, 5-15% moved into a better score category.”
This new information suggests that millions of potential borrowers can benefit from bank statement mortgages.
Traditionally lenders have asked loan applicants for bank statements from the past two or three months. This has sometimes been a headache for borrowers because statement materials are lost or incomplete. Also, lenders want the whole statement, including blank pages, something which surprises many borrowers.
Not only do most loan programs require bank statements for the past few months, they also require tax returns. Tax returns make it easy for lenders to see what borrowers have reported, income that lenders can “count” when borrowers apply for a loan.
But many borrowers don’t like to submit tax returns. Some feel their tax returns are “too complex,” that lenders will not be able to understand what the borrower has reported. In particular, self-employed borrowers may feel uncomfortable providing tax returns – returns which may show little income because the goal is to use legal deductions to hold down tax obligations.
The reality is that lenders deal with millions of mortgage applications each year. They know how to read them. They also know how to adjust tax return numbers. For instance, rental property depreciation is a “cost” for investors but gets added back for loan applications because it’s not a cash expense. Military allowances are generally not taxed. They can be “grossed-up” by underwriters to raise qualifying income. The same with child support.
Another tax return worry concerns privacy and identity theft. In the past – and with borrower permission — the IRS faxed returns to lenders. Since 2018, however, the IRS has switched to a transcript system. Instead of the entire return, only certain information is now provided. For instance, the last four digits of a Social Security number are shown instead of the complete number. You can see a model IRS transcript here.
Must Lenders Use Tax Returns?
Because tax returns seem universally required by loan programs many borrowers believe that tax returns are a must, that a rule somewhere says the lender has no choice.
Actually though, that’s not the case.
Mortgage lenders today operate within the requirements established under the 2010 Dodd-Frank legislation. This was a law enacted after the mortgage meltdown. Its main purpose is to reduce marketplace risk for borrowers, lenders and mortgage investors. One of the reasons you see so few foreclosures today is because of Dodd-Frank. Fewer foreclosures mean less risk for lenders and investors. Less risk means lower interest rates for borrowers.
Part of Dodd-Frank is known generally as the “ability-to-repay” rule. This requirement says before a residential mortgage can be originated the lender must be certain that the borrower has the ability to repay the debt.
“Under the rule,” explains the Consumer Financial Protection Bureau (CFPB), “lenders must generally find out, consider, and document a borrower’s income, assets, employment, credit history and monthly expenses. Lenders cannot just use an introductory or ‘teaser’ rate to figure out if a borrower can repay a loan.”
In other words, lenders must have a nice thick file showing that they really checked the borrower’s qualifications. They must have lots of paperwork to prove it. What the rule doesn’t say is that lenders must collect borrower tax returns.
According to Dodd-Frank, lenders “making a residential mortgage loan shall verify amounts of income or assets that such creditor relies on to determine repayment ability, including expected income or assets, by reviewing the consumer’s Internal Revenue Service Form W–2, tax returns, payroll receipts, financial institution records, or other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets.”
Bank Satement Mortgages
With a bank statement mortgage the application process is largely the same as with any mortgage. Instead of bank statements for two or three months, the lender is likely to want statements from the past 12 to 24 months.
The loan products are likely to differ from FHA, VA, and conforming loans.
Credit scores: because bank statement products are generally portfolio loans – loans kept by the lender – it is possible for lower credit scores to be accepted.
Purpose: bank statement loans may be used to finance or refinance a property. The property may be a prime residence, second home, or investment real estate.
Loan limits: Because a bank statement mortgage is a portfolio product the lender gets to set the rules. A portfolio lender may well allow borrowers to finance with mortgages that exceed the usual loan size limits. Loans of several million dollars may be available to qualified borrowers.
Cash-out: Cash-out financing may be allowed.
Down payments: Bank statement loans are not backed with mortgage insurance. The result is that large down payments are generally required, say 20% in many cases.
Interest rates: Interest rates will vary according to lender underwriting requirements. Borrowers should shop around for the best rates and terms. They should also compare interest costs for financing that requires tax returns and mortgage programs which allow bank statements.