Choice of a loan product may be considered one of the key decisions made by people and businessmen throughout their life. It does not matter what factors may result in seeking funding, whether for property purchases, expanding business, or paying off previous loans; various types of loans play an important role in interest rates people would have to pay and possibility of approval of applications submitted. There are two main methods of obtaining financial resources available today on the market – loans and bank statement loans.
This guide is dedicated to analysis of bank statement loans versus traditional loans in order to help you understand them better and choose which of these products suits you more.
Important Stats That You Need To Know
According to S&P Global, the loan portfolio held by the U.S. banking sector is estimated to be around $13.4 trillion, with mortgages being the biggest segment within this, but non-Qualifying Mortgages comprising of 85%-90% of total mortgages.
Report by Federal Reserve, the demand for non-Qualifying Mortgages has gone down to some extent due to rising interest rates and stringent conditions, but it continues to remain one of the fastest-growing types of mortgages, growing between 10%-20% per year under normal circumstances.
What Are Traditional Loans?
Conventional loan is the most common loan offered by banks, credit unions, and financial institutions. Conventional loans rely on documentation of financial history when evaluating the ability of the individual to repay the loan.
The documents include:
- W-2 forms or employment verification
- Payroll slips
- IRS taxes (1 year old or 2 years old)
- Credit history
- DTI ratio assessment
The examples of conventional loans are conventional mortgages, FHA loan, VA loan, and bank loan.
Conventional loans are offered to individuals with stable earnings. Typically, such loans target people with fixed incomes since their income and tax status are easy to verify. Consequently, such loans are considered to have a lower risk than other loans, hence resulting in low interest rates.
However, the approval process is tedious and takes time, especially among people with unstable incomes.
What Are Bank Statement Loans?
One type of alternative loans is bank statement loans, which specifically aim at self-employed individuals, independent contractors, freelancers, and small business owners. Instead of using tax returns and W-2 forms to evaluate the client’s income, banks use the deposit pattern in a certain number of months, which is mostly around 12-24 months.
Unlike the situation in which the bank uses taxable income for its calculations (which may be lower owing to many deductions), the bank takes the amount of money deposited in the account as the basis of calculation.
Features of such loans are:
- No need to provide tax returns/W-2s
- Income is calculated based on bank statements
- Flexible lending standards
- Greater emphasis on cash flow
Bank statement loans work really well when the taxable income is lower, yet there are consistent cash flows each month.
Key Differences Between Bank Statement Loans and Traditional Loans
- Income Verification
Income is traditionally verified using official documents such as tax returns and pay stubs. The income verified would be the taxable income which does not necessarily reflect the actual income of the borrower, especially for those working for themselves.
With bank statement loans, income is assessed using the deposits made in the borrower’s account. This would give a more accurate representation of the actual income earned by the borrower, especially for self-employed borrowers.
- Eligibility Requirements
Qualification requirements are stringent for traditional loans. The borrower must have an impressive credit score, continuous employment, and a lower debt-to-income ratio.
Bank statement loans have very minimal eligibility requirements. These are offered to individuals who cannot satisfy the requirements of traditional loans despite having regular income flow.
- Interest Rates
Low interest rates characterize traditional loans because they are less risky for lenders.
Bank statement loans have high interest rates compared to traditional loans because of the risks associated with verifying income.
- Down Payment Requirements
The conventional loan will have low requirements for down payment amounts, ranging from 3% to 5% for eligible candidates.
The bank statement loan will have high down payment amounts of 10% to 25%.
- Duration for Loan Approval and Processing
A lot of time is required to approve the conventional loan because of the need for paperwork.
There is much less time needed when proving income levels with a bank statement loan, but financial and business analysis is still necessary.
What Are The Advantages Of Traditional Loans And Bank Statement Loan ?
| Aspect | Traditional Loan | Bank Statement Loan |
|---|---|---|
| Interest Rate | Offers low interest rate in comparison to other types of loans | Highest interest rates because of flexible underwriting process |
| Accessibility | Easily available at most of the banks and financial institutes | Rarely found, as it needs special kind of lenders |
| Regulation and Protection | Large level of regulations and consumer protections | Low level of regulation and consumer protections |
| Payment Structure | Takes regular payment structure | Varying payment structure |
| Documents Required | Determined on the basis of income and employment records | Determined on the basis of deposits and income statement |
| Suited To | Suitable for salaried individuals | Suitable for businesspeople and self-employed individuals |
| Ease of Meeting Conditions for Taking Loan | Conditions for taking a loan are difficult | Flexible conditions for taking loan |
| Tax Deduction Effect | Cuts down on your taxable income | Helps you in qualifying for a loan if there are tax deductions |
Disadvantages Of Each Loan Type
Traditional Loans
- Hard to qualify
- Difficult for freelancers or self-employed borrowers
- Tax deductions can reduce qualifying income
- Slower approval in some cases
Bank Statement Loans
- Higher interest rates
- Larger down payment requirements
- Limited lender availability
More scrutiny of bank activity patterns
Who Should Receive Traditional Loans?
Traditional loans will be appropriate for those who:
- Receive a stable monthly wage
- Have high credit scores
- Seek loans with low interest rates
- Are new homeowners with the eligibility for government programs
If your income is stable and well-documented, traditional loans will cost less for you.
Who Should Take Bank Statement Loans?
The following group of people should opt for bank statement loans:
- Those working independently
- Those with big tax deductions
- Business persons with high cash flow and low incomes
Where your income is unstable and untaxed, bank statement loans will suit you better.
Important Factors To Consider
The following issues should be considered in choosing the type of loan:
- Credit score
- Stability and nature of income
- Down payment capacity
- Future financial plans
- Loan costs
One will also do well to consult a mortgage or finance professional like Reliance Financial to help determine which loan is best.
Conclusion
While both loans have their important uses, the types of borrowers that each loan type aims to target are quite different from each other.
For individuals who can prove a consistent source of income and good credit score, traditional loans are perfect. However, when a borrower does not fit the qualifications of traditional loans, bank statement loans are ideal for those borrowers.
In order to figure out which loan suits you best, it is essential to comprehend the distinction between the two types of loans.
FAQs
Who qualifies for bank statement loans?
The bank statement loan is aimed at self-employed people, contractors, and entrepreneurs who have made regular deposits in their accounts for the last one year to two years, along with a credit score and a down payment.
What are some reasons that the traditional loan has low-interest rates?
The traditional loan enjoys the backing of Fannie Mae and Freddie Mac, which makes it less risky for banks, allowing the bank to give low-interest rates.
Which types of loans are difficult to get?
While it could be easy for self-employed people to get bank statement loans, the bank will have strict scrutiny when looking at the bank statements of self-employed people.
What kind of loan will suit self-employed people?
The loan that will better suit self-employed persons is the bank statement loan since the loan does not consider the tax return since it may underrate one’s income. This type of loan considers cash flow, thus, enabling self-employed people to easily qualify for the loan since they have substantial deposits.
How does a down payment differ for the two kinds of loans?
While a regular loan may require down payments of between 3% to 5%, the bank statement loan requires much higher down payments of between 10% and 25%.
