S-Corp owner planning a mortgage in San Diego.

S-Corp Mortgage Guide for San Diego, California Loans

Q: How do mortgage lenders calculate income for an S-Corp owner?

A lender's seasoning period is a mandatory waiting time after you purchase or refinance a property before you can access the full after-repair value (ARV) for a cash-out refinance. Most DSCR lenders require a seasoning period of 6 to 12 months. Refinancing before the seasoning period concludes typically means the lender will base the loan amount on your original purchase price plus rehab costs, which severely limits the amount of equity you can cash out. Waiting until after the period allows you to borrow against the full market value you created through your renovations.

Q: Is my W-2 salary more important than my distributions for mortgage qualification?

To justify a higher appraised value, you should provide the appraiser with a detailed and organized renovation packet. This packet removes guesswork and provides concrete evidence of the work performed. It should include: a cover letter summarizing the major upgrades, a detailed scope of work document itemizing all improvements, compelling before-and-after photos showing the property's transformation, copies of paid invoices and receipts for materials and labor, and copies of any official building permits that were issued for the work.

Q: What are 'add-backs' and how can they help me qualify for a mortgage?

No, LTV limits for cash-out refinances vary significantly among different DSCR lenders, as each has its own guidelines and risk tolerance. While purchase loans may reach 80% LTV, cash-out refinances are often capped at 70% or 75% LTV. The specific LTV offered to an investor is influenced by several factors, including: Credit Score (higher scores typically qualify for higher LTVs), DSCR Ratio (a stronger income-to-debt ratio may result in a better LTV offer), Property Type (a single-family home might receive a higher LTV than a multi-unit property), and Loan Amount (some lenders may offer different terms based on the size of the loan).

Q: Do retained earnings count towards my qualifying income?

Your property's monthly rental income is the foundation of a DSCR loan approval. The formula is: DSCR = Gross Rental Income / Total Monthly Housing Payment. A higher rent results in a higher DSCR. This proves to the lender that the property can comfortably support a larger loan payment, which in turn allows you to qualify for a larger loan amount and maximize your cash-out.

Q: How many years of tax returns will a lender typically require?

Yes, it is often possible to pay for closing costs with the proceeds from your new loan, meaning you don't need to bring cash to closing. However, these costs are not added on top of your loan limit. Instead, the closing costs are subtracted from the total cash-out funds available to you after your existing mortgage is paid off. The total loan amount, including these costs, cannot exceed the lender's maximum LTV limit based on the property's appraised value.

Q: Should I change my compensation strategy if I'm applying for a jumbo loan?

Investors can make several avoidable errors that reduce their available cash-out funds. The most common mistakes include: Poor Documentation (failing to provide an appraiser with a thorough renovation packet can lead to a conservative and lower valuation), Refinancing Too Soon (not waiting for the lender's seasoning period to expire is a costly mistake that forces the loan to be based on cost rather than value), Lacking a Tenant (attempting to refinance a vacant property is less favorable, as lenders prefer the security of a signed lease over estimated market rents), and Ignoring Lender Differences (accepting the first loan offer without comparing options can mean missing out on better LTV limits or shorter seasoning requirements from other lenders).

Q: Why is it important to talk to my accountant before buying a home?

The ideal time to begin the refinance process is 30 to 45 days before your lender's seasoning period expires. This allows you to gather all necessary documentation, secure an appraisal, and complete underwriting so that you can close immediately once the seasoning requirement is met. Crucially, by this time, the property should also be 'stabilized,' which means you have a qualified tenant in place with a signed lease and have collected at least the first month's rent.

Specialized In Jumbo Loans, Investor Loans, DSCR Loans, Non-QM Financing, Commercial Mortgages, and Tax-Informed Lending Strategies

Published By

David Ghazaryan

Owner / Broker / Banker

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TL;DR

When seeking a mortgage as an S-Corporation owner, especially in competitive markets like San Diego, understanding how lenders view your income is essential. Here is a brief overview:

Income Calculation: Lenders evaluate both your W-2 salary and your business's distributions to determine your total qualifying income for a loan.
Strategic Planning: To maximize your borrowing capacity, it's often necessary to strategically structure your compensation for at least two years prior to applying for a mortgage in California.
Income Add-Backs: Your qualifying income can often be increased by adding back non-cash expenses like depreciation, which can be a significant factor in your San Diego home loan approval.

How Mortgage Lenders Calculate S-Corporation Income

For an S-Corporation owner, qualifying for a mortgage isn't as simple as presenting a pay stub. Lenders perform a detailed analysis of both your personal and business financials to establish a stable, reliable income figure. This process involves looking at two primary sources: your W-2 salary and the business's net income.

First, lenders review your W-2 salary, the amount you pay yourself as a formal employee of your S-Corp. This is the most straightforward part of the calculation. They will verify this using your personal tax returns and recent pay stubs.

Second, they analyze the business's profitability through the Schedule K-1 (Form 1120-S). The K-1 shows your share of the corporation's income, losses, deductions, and credits. A lender’s underwriter starts with the ordinary business income (or loss) reported on the K-1 and then makes specific adjustments. They are trying to determine the company's true cash flow and how much of that profit is available to you without negatively impacting the business's operations.

Typically, lenders will request the last two years of both personal and business tax returns to calculate a 24-month average income. This demonstrates stability to the underwriter. If your income has increased, they may use a 12-month average, but a declining income trend is a major red flag and will likely result in them using the lower, more recent figure. (The data, information, or policy mentioned here may vary over time.)

Salary vs. Distributions: What Matters for a Loan?

This is the central dilemma for many S-Corp owners. To minimize self-employment taxes (Social Security and Medicare), you might pay yourself a modest 'reasonable salary' via W-2 and take the rest of the profits as distributions. While this is a smart tax strategy, it can create challenges for mortgage qualification if not managed correctly.

From a lender's perspective, both components matter, but they are viewed differently:

W-2 Salary: This is seen as stable, predictable income. A consistent salary over two years is a strong positive factor.
Distributions: This income is viewed as more variable. Lenders will only count income from distributions if the business's financial health supports it. They analyze the S-Corp's tax returns to ensure the distributions did not exceed the business's net income or deplete its cash reserves.

S-Corp owner reviewing financial documents for a mortgage.

Example:

Imagine you own a successful consulting firm in San Diego. In 2022 and 2023, you paid yourself a W-2 salary of $60,000 to reduce FICA taxes. The business's net profit after all expenses (including your salary) was $150,000 each year, and you took that full amount in distributions.

An underwriter would typically calculate your qualifying income like this:

W-2 Salary: $60,000
Distributable Business Income: $150,000
Total Qualifying Income: $210,000

However, if you took distributions of $200,000 while the business only profited $150,000, the lender would only use the $150,000 figure. They will not use distributed income that exceeds the company's actual earnings for that period.

The key is consistency. Erratic, large, one-time distributions are less favorable than a track record of steady, supportable distributions combined with a reasonable salary.

The Impact of Retained Earnings on a San Diego Mortgage

Retained earnings are the profits you deliberately leave in the business for growth, cash flow, or future investments. This is a prudent business practice, especially for companies that need to manage inventory or plan for capital expenditures. However, for mortgage qualification purposes, retained earnings are not counted as your personal income.

Lenders are concerned with the cash that is actually available to you to pay the mortgage. Money left in the business operating account is considered the business's asset, not yours. If you claim that income, the underwriter will need to see proof that withdrawing it would not harm the business. A business liquidity test might be performed by analyzing balance sheets and profit and loss statements. (The data, information, or policy mentioned here may vary over time.)

A beautiful home in San Diego, representing a homeownership goal.

For instance, if your retail business in La Jolla needs to maintain $100,000 in cash for seasonal inventory purchases, you cannot present that $100,000 as part of your qualifying income. An underwriter will recognize it's essential for the company's ongoing operations. Attempting to count retained earnings often results in the lender disallowing it, reducing your total qualifying income.

Can I Add Back Paper Losses to My Qualifying Income?

Yes, and this is one of the most significant advantages for self-employed borrowers. Your business's net income on paper is often lower than its actual cash flow due to non-cash expenses, also known as 'paper losses'. Underwriters are trained to identify these and add them back to your net profit, increasing your qualifying income.

Common add-backs for an S-Corporation include:

Depreciation: The annual deduction you take for the wear and tear on business assets like vehicles, equipment, and property.
Amortization: The expensing of intangible assets (like patents or trademarks) over time.
Depletion: Used for businesses that extract natural resources.

Example of Add-Backs in Action:

Let's say your San Diego-based S-Corp's tax return shows a net profit of $120,000.

Net Profit (from Form 1120-S): $120,000
Depreciation Expense Listed: $25,000
Amortization Expense Listed: $5,000

An underwriter would calculate your adjusted business income as:

$120,000 (Net Profit) + $25,000 (Depreciation) + $5,000 (Amortization) = $150,000

In this case, your qualifying income from the business is $30,000 higher than what the bottom line of the tax return suggests. This can make a substantial difference in the loan amount you qualify for.

How Many Years of Tax Returns Are Needed?

The industry standard for documenting S-Corporation income is a two-year history. Lenders require the most recent two years of complete, filed personal tax returns (Form 1040) and business tax returns (Form 1120-S), including all schedules like the K-1.

This two-year lookback period allows underwriters to:

Establish Stability: They can see if your income is consistent, increasing, or declining.
Calculate an Average: They typically average the income over 24 months to smooth out any fluctuations.
Verify Business Health: Reviewing two years of returns provides a clearer picture of the company's long-term viability.

In some limited circumstances, a lender might consider just one year of tax returns. This is generally reserved for strong files where the business has been established for at least five years and other compensating factors are present, such as excellent credit, a large down payment, and substantial cash reserves. However, for most S-Corp borrowers, especially those in competitive markets like San Diego, planning to provide a full two-year history is the safest approach. (The data, information, or policy mentioned here may vary over time.)

Structuring Pay for Jumbo Loans in La Jolla

Jumbo loans, which are mortgages that exceed the conforming loan limits set by the FHFA, come with more stringent underwriting requirements. For high-value real estate markets like La Jolla, where jumbo loans are common, lenders scrutinize an S-Corp owner's income even more closely.

When preparing to apply for a jumbo loan, the 'low salary, high distribution' strategy becomes riskier. Jumbo underwriters place a premium on predictable, documented income. A higher, more consistent W-2 salary is viewed much more favorably than large, irregular distributions.

Consider increasing your W-2 salary to a level that more closely reflects your total compensation for at least the 24 months leading up to your mortgage application. This demonstrates a stable financial base capable of handling a larger mortgage payment. While it may mean paying more in FICA taxes temporarily, it significantly strengthens your loan application and increases your chances of approval for a higher loan amount. (The data, information, or policy mentioned here may vary over time.)

Advising Your Accountant Before a Home Purchase

Your accountant or CPA is your partner in tax strategy, but their primary goal is often to minimize your tax liability. This can be at odds with the goal of maximizing your qualifying income for a mortgage. It is essential to communicate your homebuying plans with them 12 to 24 months in advance.

Here are key points to discuss with your accountant:

Share Your Goal: Inform them that you are planning to buy a home and need to show as much stable income as possible on your tax returns.
Discuss 'Reasonable Compensation': Work with them to establish a W-2 salary that is both defensible to the IRS and strong enough for mortgage underwriters.
Be Strategic About Expenses: Avoid writing off excessive or borderline expenses in the years leading up to your application. Every dollar of write-offs reduces your qualifying income.
Manage Large Purchases: Be mindful of Section 179 deductions, which allow you to expense the full cost of equipment in one year. While great for taxes, it can create a huge one-time dip in your net income that could derail a mortgage approval. Consider spreading the depreciation over several years instead.
Maintain Consistency: Emphasize the need for consistent salary payments and predictable distributions. Avoid large, undocumented fund transfers from the business to your personal accounts.

If you're an S-Corp owner ready to turn your business success into a new home, understanding your mortgage options is the next step. Apply now to receive a personalized analysis and position yourself for approval.

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.