How Income is Calculated for Loan approval in 2010
Posted On: August 3rd, 2010 by James Posted In: FHA Mortgage • Mortgage Programs • Mortgages • Refinancing
The rules of the mortgage game keep changing. Ultimately, the changes are a reflection of a much more risk averse lending environment. It is increasingly difficult to get approved for a mortgage. Now, don’t get me wrong, this isn’t the end of the world, and if you have decent credit, and a stable and verifiable employment/income history you will likely be approved for some kind of financing.
The thing to be aware of now is that what is considered to be “verifiable” by mortgage underwriters is certainly not what it used to be, nor what a sane person might expect it to be.
THE COMMON TYPES OF INCOME:
1. SALARIED/WAGE EARNER: If you are a regular wage earner and get a set salary, or a set hourly schedule and rate, you are in for the easiest path of income documentation. You will only need two years of W2′s and 30 days most recent pay stubs. If you have recently been out of employment, or have what is deemed to be a considerable “employment gap”, sometimes this will create complications in your mortgage approval. If the gap is only a few months, and the new employment is related to the field of the previous employment, there is usually no problem in overcoming this. If the gap is more significant, most lenders are now looking for a minimum of 6 months on the new job before approving it.
If you are a salaried wage earner, you also have the benefit of immediately getting credit for any salary increases. If you have been making $40k per year, but a month ago got a raise to $45K, we can qualify you based on the higher income once it’s reflected in a pay stub (provided your employment is not from a family owned business or one that you have an ownership interest in).
2. BASE PLUS COMMISSION, OR BONUS INCOME: Commission and bonus income can only be counted after a 2 year history of receiving it is documented. In some cases, if you’ve been getting an annual bonus, and have only been on the job for 18 months for instance, we can count some or all of the bonus income with a letter from your employer. But the ideal documentation for commissions or bonus income in a mortgage application is a two year history, with evidence that it will continue.
3. (1099) SELF EMPLOYED: Self employed workers get the short end of the underwriting stick without a doubt. We generally need a two year history of self employment in the same field or company. We would need two years full tax returns, and in some cases would ask for two years full business tax returns. The allowable income for self employed folks is the adjusted gross income after expenses have been subtracted. For many self employed people, the write offs they are afforded greatly reduce their taxable income, and disqualify them for the loan amount they were hoping for.
Many self employed borrowers also hope to be able to have the books for their current business year looked at, like a profit-loss statement. These are inadmissible for underwriting. The only thing we can use are complete and filed personal tax returns. We will then give credit for the previous 24 month average AGI. If the borrower has filed an extension, this is okay, we would use the most recent two years complete and filed returns as the case may be.
Also, if the self employed borrower exhibits “declining income” from one year to the next, this can create a loan decline. If the decline isn’t severe, we can sometimes work around this.
4. S-CORP, BUT PAY YOURSELF WITH W2: This is becoming more common lately. And 9 times out of 10, this will fall back into the self employed track for income approval. Someone who performs a service or what have you creates an “S-corp” that then pays out a fixed salary. Even though this borrower has a clear and document-able income stream, this salary is seen by underwriters as a liability on the overall corporation. So full business tax returns would be required to make sure that the company isn’t operating at a loss. If it is, the borrower is sunk and cannot count the salary. However- if the borrower owns less than 25% of the corporation, we can count the salary. Crazy right?
5. CAPITAL GAINS: Capital gains can be counted as income if there is a 2 year history of receiving them in your tax returns. The 2 year total is added together and divided by 24 to credit a monthly gross into your debt to income ratios.
6. ALIMONY/CHILD SUPPORT: Alimony and Child support can be counted as income if it is documented in a filed divorce decree. With regards to child support, we would need to prove that it would continue for a minimum of 3 years. Many cases this is proven with age verification on the children, as child support is discontinued when the child turns 18.
7. RETIREMENT INCOME: Retirement income is just like anything else, it’s mainly documented by 2 years of full tax returns. There is also sometimes “tax-free” retirement income, such as annuities or ROTH IRA’s. We just need to document the contract, and the deposit history. We can also “gross up” tax free income to make it compare better to taxable income. This is usually done by multiplying the income by 125%.
8. SOC. SECURITY/DISABILITY: Social security income and disability income can be documented with an offer letter and a deposit history. This income can also be grossed up if shown to be tax free.
Again, working with a professional, and experienced mortgage broker can help you to identify problems early on in the process, and keep you on the right track.
4 Responses
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Hi Wayne, excellent question- I just updated this post to address this, as well as added some other common income types. To answer your question directly right here though- we can give you credit for any income increases in a salary/wage scenario. We just need a paystub that reflects the income increase.
For self employed income analysis, we take the average of the previous 24 months. P/L statements don’t count, only complete and filed tax returns.
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Sarah says:
James, what about income from a rental? Many folks are renting out their homes rather than selling. How long does it take to be able to count that toward your income for mortgage purposes?
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Hi Sarah, 75% of the total income from a rental can be counted. Ideally, this will be documented on the schedule E of a filed tax return. The reason we only credit 75% is that underwriters factor in some vacancy. There are some additional rules if someone is trying to “convert” their existing primary residence into a rental. Its much more difficult to count that rental income. I should probably give that its own post.
James – great info!
I’m curious, how are the two years of income combined into one’s official income? Are they averaged or is the recent year weighed more heavily?
Thanks!