Bank Statement Loan Vs Conventional Loan: What’s The Difference?

Whether you’re mapping out your financial future, considering investment properties, or just curious about the mortgage landscape, understanding different types of mortgages is key.

Investing in real estate can be as complex as it is rewarding.  Bank statement loans vs conventional loans are two routes you can take, each with its own set of rules.

Here’s what you need to know to invest wisely.

Key Takeaways

Bank Statement Loans (BSLs):

• Tailored for the self-employed: If your income is more ‘here and there’ than ‘9 to 5’, BSLs have got you covered.
• Bank statements as proof: Lenders look at 12 to 24 months of your bank statements to gauge your income.
• Higher interest rates: Because they’re a bit riskier for lenders, BSLs often come with higher rates.
• Bigger down payments: You might need to front more cash at the start compared to conventional loans.

Conventional Mortgages:

• The traditional route: Ideal if you have a steady job and regular income.
• Standard documentation: W-2s, tax returns, and pay stubs are the golden tickets here.
• Lower interest rates: They’re usually more wallet-friendly in the long run.
• Flexible down payments: You can start with as little as 3% down, but less than 20% means you’ll pay PMI.

What Are Bank Statement Loans?

Bank statement loans are a type of non-conventional mortgage lending option tailored for individuals who have non-traditional income streams.

Bank statement mortgages offer an alternative route for borrowers who might not qualify for a conventional loan due to non-traditional income sources.

These are particularly beneficial loans for self-employed individuals, freelancers, and business owners. 

For instance, if you’re a freelancer, your income might come from various clients and projects, rather than a single employer. 

Or, as a small business owner, you might have income from sales, services, or contracts that vary month-to-month. 

Other non-traditional income sources could include rental income, investment returns, royalties, or even income from online platforms and gig economy jobs.

These diverse forms of income can make your financial situation look complex on paper. A bank statement loan allows you to sidestep the usual proof of income documents and use your bank statements to show lenders a more accurate picture.

For example, let’s say your tax returns show you made $100,000 last year, but in reality, you earned $200,000 because you wrote off a significant business expense. Your bank statements would reflect the higher income level, making you a more attractive candidate for a mortgage.

What advantages do bank statement loans offer over conventional mortgages?

If you’re a self-employed freelancer or a startup founder. Your income is as unique as your business model – it ebbs and flows, spikes with a successful project, then plateaus as you prep for the next. Standard W-2s? They don’t tell your whole story. Tax returns? They might not capture the real-time success of your latest venture.

That’s where bank statement loans come in. Lenders take a deep dive into your bank statements, typically from the past 12 to 24 months.

What’s in it for you? Read on.

Income Verification

Instead of relying on the standard documentation like W-2 forms and tax returns, which may not fully capture the borrower’s financial health, lenders will review 12 to 24 months of bank statements. This allows them to:

• Verify deposits and understand the applicant’s income pattern.
• Assess the stability and consistency of cash flow into the accounts.
• Evaluate the borrower’s ability to sustain mortgage payments over time.

Credit Requirements for Bank Statement Loans

Credit requirements for bank statement loans can vary widely by lender but are generally more flexible than conventional loans. Some lenders may accept borrowers with credit scores as low as 580. 

However, like conventional loans, better credit scores often result in more favorable loan terms.

Down Payment and Interest Rates

Bank statement mortgages typically require higher down payments, often around 10% to 20%, due to the perceived higher risk by lenders. Interest rates for these loans may also be higher compared to conventional mortgages, reflecting the increased risk associated with less traditional income verification methods.

Loan Limits and Property Types

Loan limits for bank statement mortgages can vary significantly by lender and may not adhere to FHFA limits. 

These loans can be used for a wide range of property types, including primary residences, second homes, and investment properties, offering flexibility for borrowers with non-traditional income sources.

By analyzing personal or business bank statements, lenders can calculate a qualifying income that reflects the borrower’s true earning capacity. 

This often involves averaging the deposits over the selected period and subtracting non-business or non-recurring transactions to arrive at a monthly income figure.

Pros & Cons of Bank Statement Loans

Pros

• Flexibility in proving income, which is ideal for those with complex financial situations.
• Quicker approval times, as the process can be less document-intensive than traditional loans.
• Opportunity for those denied by traditional lenders to secure a mortgage and invest in property.

Cons

• Higher interest rates compared to conventional loans due to the perceived increased risk.
• Larger down payments required to offset the lender’s risk.
• Stricter scrutiny of bank statements and financial history.

So if you’re a modern entrepreneur or freelancer this might be a better option. These mortgages are designed for go-getters who don’t fit into the traditional employment mold.

Conventional Mortgages: The Traditional Path

Conventional mortgages are the most common type of home loan, widely available through banks, credit unions, and other financial institutions. Unlike government-insured loans (like FHA or VA loans), conventional mortgages are not guaranteed by the federal government.

Conventional mortgages are conforming loans, meaning they meet the requirements set by Fannie Mae and Freddie Mac. 

These two government-sponsored enterprises (GSEs) buy mortgages from lenders and sell them as mortgage-backed securities to investors. 

This process helps to free up capital, allowing lenders to offer more loans to potential homebuyers.

Now, about Fannie Mae and Freddie Mac: They were established by Congress to ensure a stable supply of mortgage funds across the country. By buying mortgages from lenders and packaging them into securities for sale to investors, they provide liquidity, stability, and affordability to the mortgage market. 

This secondary mortgage market activity helps to lower interest rates for homeowners and supports the availability of mortgage credit.

And the types? You’ve got fixed-rate loans, where the interest rate stays constant over the years, offering a sense of financial stability. Then there are adjustable-rate mortgages, which might start off lower but can change with market conditions.

Choosing the right mortgage is a big decision, and it pays to shop around. A financial advisor or trusted mortgage broker can be invaluable in navigating these waters.

They are ideal for borrowers with a stable income, good credit history, and the ability to make a down payment. They’re particularly attractive to those who can afford a down payment of 20% or more, which typically eliminates the need for private mortgage insurance (PMI).

In a nutshell, conventional mortgages are a flexible financing option for homebuyers with strong financial standing.

What advantages do conventional mortgages have over bank statement loans?

Conventional mortgages are popular because they often offer competitive interest rates and terms.

To qualify for a conventional mortgage, borrowers typically need to:

• Have a good credit score: The higher the credit score, the better the interest rates and terms a borrower may receive.
• Provide proof of income: Lenders will look at tax returns, W-2 forms, pay stubs, and other documentation to verify the borrower’s income.
• Have a stable employment history: A consistent work history can show lenders that the borrower has a reliable source of income to make mortgage payments.
• Make a down payment: While it’s possible to find conventional loans with down payments as low as 3%, many lenders prefer a down payment of 20% to avoid the need for private mortgage insurance (PMI).
• Debt-to-income ratio (DTI): This ratio measures how much of a borrower’s income is spent on debt payments, including the mortgage. A lower DTI can improve the chances of qualifying for a mortgage.

Conventional mortgages can be either fixed-rate or adjustable-rate:

• Fixed-rate mortgages have the same interest rate for the entire term of the loan, which can provide stability and predictability in payments.
• Adjustable-rate mortgages (ARMs) have an interest rate that may change over time, usually in relation to an index, which can lead to lower initial payments but potential increases in the future.

Credit and Income Requirements

Conventional loans typically require a stronger credit history and higher credit scores than government-backed mortgages. Borrowers often need a credit score of 620 or higher, although the best interest rates are reserved for those with scores above 740. 

Lenders also look for a stable income history and a debt-to-income (DTI) ratio—your monthly debt payments divided by your gross monthly income—of 43% or lower.

Down Payment

One of the most significant advantages of conventional mortgages is the flexibility in down payment requirements. While many people believe a 20% down payment is necessary, some conventional loans allow for as little as 3% down. 

However, putting down less than 20% typically requires private mortgage insurance (PMI), an additional monthly cost until you've built up 20% equity in your home.

Loan Limits and Property Types

Conventional loans adhere to loan limits set by the Federal Housing Finance Agency (FHFA). In 2023, the standard loan limit for a single-family home in most of the U.S. was $726,200. 

These loans can be used to purchase a variety of property types, including primary residences, second homes, and investment properties.

Pros & Cons of Conventional Loans

Pros

• Lower Interest Rates: Good credit scores can lead to potentially lower interest rates compared to other loan types.
• Flexible Down Payments: You have options, from 3% to 20% down payments.
• Versatile Property Types: Conventional mortgages cover a wide range of properties, including single-family homes, condos, multi-unit properties, and more. Whether you’re buying a cozy house or investing in a duplex, conventional loans have you covered.

Cons

• Flexibility in Proving Income: Ideal for those with non-traditional income sources.
• Potential Approval: Even if you’re self-employed, bank statement loans offer a path to homeownership.

Choosing the Right Path for You

When deciding between a conventional mortgage and a bank statement mortgage, consider your financial situation, credit history, and the stability of your income. Conventional mortgages are well-suited for borrowers with strong credit scores, stable W-2 income, and the ability to make a substantial down payment. 

On the other hand, bank statement mortgages offer a viable alternative for self-employed individuals or those with fluctuating income, providing a way to qualify for a home loan based on actual cash flow rather than traditional income verification methods.

Conclusion

The journey to homeownership is filled with important decisions, not least of which is choosing the right type of mortgage. 

Conventional and bank statement mortgages cater to different borrower profiles, each with its own set of advantages and considerations. 

Remember, consulting with a mortgage professional can provide personalized advice and help you explore all available options, ensuring you make the best decision for your unique situation.