Planning to buy a home? It is very important to understand how lenders calculate your employment or business income for qualifying purposes. The income you earn may not be what mortgage lenders can use to qualify you for a home loan, especially if you are self-employed.
Are You a Salaried or Hourly Wage Home Buyer?
Your income is straight forward to calculate. Lenders use your gross monthly income before taxes and other deductions as your qualifying income. If you are an hourly full- time employee, lenders will multiply your hourly wage by 2080 hours (40 hours per week X 52 weeks per year) and then divide by 12 for monthly gross income. These are the additional requirements for salaried or hourly employment:
Documentation includes 30 day pay statements (2 if paid twice per month/bi-weekly and 4 if paid weekly) and 2 years W2s.
You need 2 years of total employment history to consider your income. Time spent in school studying for your current profession can be used as “employment” history to satisfy this requirement.
Switching employers?
No problem, as long as it is from one salaried/hourly job to another and your new job is within the same profession (generally). Notify your lender if you plan to switch employers to confirm there are no issues.
Overtime and bonus income?
It is averaged over the 2 prior years to be used as qualifying income. Additionally, your employer must verify that OT or bonus income will continue. If OT or bonus income is declining, it might not count at all.
Part-time job?
You need to show 2 years working part-time to count it as qualifying income.
Working 2 jobs?
Income can be used if you verify at least 2 years working 2 jobs simultaneously.
Employment gaps?
These are defined as more than 3 months between jobs. Work for at least 6 months full-time to overcome the employment gap and count current income.
Tips or commission income?
2 years history of receipt is required and averaged over past 2 years (if increasing, if not, recent lower year used). If tips or commission exceeds 25% of your income, then 2 years Federal Tax Returns are needed to document any expenses claimed as part of your job.
GI Bill Education income?
Paid to Veterans or their spouses/children attending higher education full time. Many Veterans do not realize this income cannot be used to qualify for a mortgage loan, unfortunately.
Seasonal or Skilled Trade income?
If unemployment compensation is part of your business during the year, then this compensation can be used for qualifying income. Again, 2 years history of receipt necessary.
Do your work hours fluctuate, like RNs and Pilots?
Income is averaged year to date or based on previous years W2 average.
Are you paid cash under the table? This income can only be counted if documented on 2 years tax returns. The common theme above is 2 years verification of income. This is because mortgage lenders count income for qualifying purposes if you can document 2 years receipt and a reasonable expectation that it will continue for the next 3 years.
Are You a 1099 Contractor or Business Owner?
Determining your income is a bit more complicated. If you file a Schedule C (Profit or Loss From Business) on 1040 Federal Tax Return, then income is calculated as follows:
Line 31 (Net Profit or Loss) + Line 13 (Depreciation) – Line 24b (Meals and Ent) = Qualifying income for that tax year.
Example:
Line 31 is $58,000 + Line 13 at $2500 – Line 24b at $500 = $60,000 qualifying annual income or $5000 per month. The lender averages your last 2 years of qualifying income if income has increased from year to year or uses most recent lower year if income has declined.
Example Increasing Income:
2021 qualifying income $65,000 and 2020 qualifying income $55,000. Then, 2 years are averaged for total income of $60,000 per year, $5000 per month. Note, there are no special exceptions for income declines due to the pandemic.
Example Decreasing Income:
2021 qualifying income $55,000 and 2020 qualifying income $65,000. Then, the most recent lower year is used for total income of $55,000 per year, $4583 per month.
Year to date profit and loss statement
Required for the current year when self-employed. It is used to support the qualifying income already determined from your previous 2 years tax returns.
If you are self-employed, plan well in advance to improve your qualification prospects for the home you want to buy. Many 1099 independent contractors and business owners limit the amount of income available for mortgage qualifying with business expenses and deductions.
Therefore, it is a good idea to meet with your financial planner, CPA or tax advisor early in the process to develop a plan to ensure sufficient net taxable income to qualify for the purchase price you prefer.
Whatever the total housing payment will be for your desired home, you need to earn at least double that amount in qualifying income, assuming you have no other debt.
Example:
If you are looking at a $500,000 home and have 20% down, your principal and interest will be approx $2400 at 6% on the $400,000 loan. If property taxes, insurance and homeowner association dues (if applicable) are $600, then the total housing payment is $3000 per month. With no other debt, you need to earn at least $6000 per month to qualify for that payment.
Conventional financing may allow for up to 50% debt-to-income ratio as long as you have good credit (680+ is considered “good”). If you have other debt, such as an auto loan and credit card payments totaling $500 per month, then you need to qualify for $3500 per month in total debt ($3000 house payment + $500 auto and credit card payments). At least $7000 per month/$84,000 per year in qualifying income is needed in this scenario.
There are many different ways people earn income in the 21st century but not all can be counted toward your qualifying income for a mortgage. If it can be documented on paper and/or tax returns, it can usually be counted.
However, it is best to discuss with a professional mortgage lender in your market to determine where you currently stand financially and what you need to do to succeed in this housing market.
