The Two-Year Average: Why Underwriters Devalue Variable Income
High-earning professionals in Los Angeles and Beverly Hills often face a frustrating paradox: despite having substantial income, their jumbo loan applications are denied. The culprit is typically the lender's rigid adherence to a two-year income average for any earnings that are not a fixed salary. This practice is designed to mitigate risk by ensuring a borrower's ability to repay is based on stable, predictable income, not a single windfall.
Underwriters see variable income—which includes commissions, bonuses, overtime, and self-employment profits—as less reliable than a fixed salary. To them, a massive bonus last year is not a guarantee of future performance. Their solution is to calculate a conservative monthly income figure by adding up the total variable income from the last 24 months and dividing by 24. (The data, information, or policy mentioned here may vary over time.)
How Income Devaluation Works in Practice
Consider a tech executive in Los Angeles who earns a base salary of $250,000.
- In 2022, she received a performance bonus of $50,000.
- In 2023, after a stellar year, her bonus was $200,000.
She feels confident applying for a mortgage based on an annual income of $450,000 ($250k salary + $200k bonus). However, the lender calculates her qualifying income differently. They will use her full salary but average the bonus:
- Total Bonus Income: $50,000 + $200,000 = $250,000
- Average Monthly Bonus: $250,000 / 24 months = $10,416
- Annualized Bonus: $10,416 x 12 = $125,000
Her qualifying income in the eyes of the lender is $375,000 ($250,000 salary + $125,000 averaged bonus), a staggering $75,000 less than her actual earnings last year. This devaluation can be the difference between approval and denial for a luxury property in Beverly Hills.
Common Documentation Mistakes by Self-Employed Borrowers
For self-employed individuals, the underwriting process is even more scrutinized. Simple documentation mistakes can instantly derail an application. Avoiding these common errors is critical for presenting a clear and accurate financial picture.
- Providing Incomplete Tax Returns: Submitting a Form 1040 without all the required schedules (like Schedule C for sole proprietors, Schedule E for rental income, or K-1s for partnerships/S-corps) is an immediate red flag. Underwriters need the complete picture to understand your business's financial health.
- Mixing Personal and Business Expenses: Using business accounts for personal expenses makes it incredibly difficult for an underwriter to determine the true profitability and cash flow of your enterprise. Maintain separate accounts and practice clean bookkeeping.
- Aggressive Tax Write-Offs: While minimizing your tax liability is smart business, excessive write-offs can make your adjusted gross income (AGI) appear too low to qualify for a substantial loan. Lenders primarily look at the income you claim after deductions, not your gross revenue.
- Disorganized Financial Statements: Submitting a messy or confusing Profit & Loss (P&L) statement forces the underwriter to make assumptions, which are rarely in your favor. Your P&L should be clear, detailed, and align perfectly with your business bank statements.
How to Document Large, Inconsistent Commission or Bonus Payments
If a significant portion of your income comes from irregular payments, the key is to build a narrative of consistency over time. You need to prove that while the timing and amount may be variable, the income itself is a reliable part of your long-term earnings.
Create a Comprehensive History
Don't limit yourself to the required two years of documentation if you have a longer history. Providing five years of tax returns showing consistent, albeit fluctuating, bonus or commission income demonstrates a stable earning pattern. For instance, a Beverly Hills real estate agent can show that despite lumpy commissions, their annual income has remained strong for several years.
Essential Documentation Checklist:
- Year-to-Date (YTD) Pay Stubs: A current pay stub showing strong YTD earnings can help validate a recent increase in income.
- Verification of Employment (VOE): Request a detailed VOE from your employer that outlines your compensation structure. It should explain how bonuses or commissions are earned and state the likelihood of their continuance.
- Bonus/Commission Award Letters: Include any official documentation that specifies the amount and reason for large payments. This provides context beyond just a number on a tax return.
Presenting Business Financials for Maximum Qualification in Beverly Hills
For business owners, the goal is to present your company's financials in the most professional and transparent way possible. Underwriters are trained to be skeptical, and a polished, well-organized package builds trust.
- Obtain a CPA-Prepared P&L: A year-to-date P&L prepared and signed by a Certified Public Accountant (CPA) holds significantly more weight than one you create yourself. It signals to the lender that the figures have been professionally reviewed and are accurate.
- Provide 12-24 Months of Business Bank Statements: Your bank statements are the ultimate proof of cash flow. They must corroborate the revenue figures on your P&L. Be prepared to source any large, non-typical deposits to show they are from legitimate business activities.
- Address Add-Backs Intelligently: Lenders may allow certain non-cash expenses, like depreciation or amortization, to be 'added back' to your net income. Work with your mortgage professional and accountant to identify these opportunities and present them clearly to the underwriter. (The data, information, or policy mentioned here may vary over time.)
The Power of a Detailed Letter of Explanation (LOX)
A Letter of Explanation is your opportunity to speak directly to the underwriter and provide context that the numbers alone cannot. A well-written LOX can clarify inconsistencies, explain trends, and paint a more complete picture of your financial stability.
Use a LOX to:
- Explain a significant income increase: 'In Q3 2023, my consulting firm secured a three-year contract with a major Los Angeles-based client, which resulted in a 70% increase in monthly revenue. This is a recurring contract and represents our new baseline income.'
- Justify a large, one-time business expense: 'Our 2022 tax returns reflect a $100,000 equipment purchase. This was a one-time capital investment that will not recur and has increased our production capacity, leading to higher projected profits for the coming years.'
- Clarify the nature of your business: Describe what your business does, its history, and why your income patterns are normal for your industry.
How Lenders Treat Restricted Stock Units (RSUs)
For many in the Los Angeles tech and corporate sectors, RSUs are a substantial part of their compensation. However, lenders view unvested RSUs as potential, not actual, income. To use RSU income for qualification, you must demonstrate a history of it being paid out.
- Vesting History is Key: Lenders typically need to see a two-year history of Restricted Stock Units vesting and appearing as income on your pay stubs or W-2s.
- Provide Full Documentation: You must provide the complete RSU award agreement from your employer, which details the full vesting schedule (e.g., how many shares vest and when). You will also need brokerage statements showing the shares being deposited and subsequently sold.
- Calculation: Similar to bonuses, lenders will average the income received from vested RSUs over the past 24 months to arrive at a qualifying monthly figure. (The data, information, or policy mentioned here may vary over time.)
What If My Income Grew Significantly Last Year?
This is one of the most common frustrations for high achievers. You've had a career-defining year, but the lender wants to penalize you for your performance two years ago. While conventional Fannie Mae and Freddie Mac guidelines are rigid on the 24-month average for variable income, there are other solutions.
This is where working with a mortgage brokerage with access to a wide network of lenders becomes invaluable. Portfolio lenders and those offering Non-Qualified Mortgages (Non-QM) have more flexible underwriting guidelines. They are often willing to:
- Consider a 12-month income average for borrowers with strong credit and assets.
- Utilize bank statement loans, which qualify self-employed borrowers based on the average deposits into their business bank accounts over 12 or 24 months, without needing tax returns. (The data, information, or policy mentioned here may vary over time.)
- Make common-sense underwriting decisions based on the overall strength of the borrower's financial profile.
Should My Accountant Get Involved in the Mortgage Process?
For any applicant with self-employment or complex variable income, the answer is an emphatic yes. Your accountant is a critical ally in the mortgage process. Their involvement adds a layer of credibility and professionalism that underwriters value.
Your CPA can:
- Prepare an accurate, audited P&L: This is the gold standard for financial statements.
- Write a formal letter: A letter from your CPA can confirm the health of your business, explain that it is not negatively impacted by tax deductions, and attest to its long-term viability.
- Help organize financials: They can ensure all documentation is consistent, accurate, and presented in the format lenders prefer.
Partnering with your accountant from the beginning of the process ensures your financial story is told clearly and accurately, dramatically increasing your chances of securing a jumbo loan approval for your home in Los Angeles.
If your complex income is creating challenges with traditional lenders, don't get discouraged. A mortgage strategist can help structure your application and connect you with lenders who understand variable compensation. When you're ready to see how an expert can navigate these hurdles for you, take the first step and apply now.
Author Bio
David Ghazaryan is the expert mortgage strategist and founder behind iQRATE Mortgages. With a mission to fund home loans that traditional banks won't touch, David specializes in helping clients with unique financial situations, including those recovering from foreclosure or bankruptcy. He expertly crafts smart, strategic, and stress-free mortgages by leveraging a vast network of over 100 lenders to secure competitive rates for investors and homebuyers alike. Praised for exceptional customer service, David has helped hundreds of families with a 97% satisfaction rate, guiding them to the mortgage they deserve.
References
Fannie Mae Selling Guide: Variable Income
