Guest Post by Mark Anderson of Cornerstone Mortgage
As mortgage guidelines have tightened over the last several years, income verification in particular has become more difficult. The rules of mortgage approval, effectively set by the quasi-government agencies Fannie Mae, Freddie Mac and FHA, are quite particular when it comes to what income can and cannot be considered as a part of your mortgage application.
If you are an average W2 employee with a base salary, the income calculation procedures are logical. You take your base yearly salary and determine the monthly gross – simple, right? However, if your income fits into any of the following categories, the rules could make your head spin:
- Seasonal work
- Multiple jobs
- Contract work
- Dividends/capital gains
- Rental property
- New employment
For each of these categories, there could be a big difference between what you make in reality and what we can consider for your loan application. Without going into detail about each category, I’d like to point out a few common areas where the way the industry calculates your income could dramatically affect your loan options. Guidelines can vary between loan programs, so keep in mind that the details of your exact situation matter in a big way.
If you work in the service industry it is quite common to receive some or most of your income in tips. The problem with this for loan purposes is that often large chunks of your actual income are unreported to the IRS. Also, mortgage approval guidelines are geared toward stability. This is why in order to count even fully IRS reported tips, we must show at least 1 year of job history at the same employer. One other issue with tips and service industry work is that often the number of hours worked per week can fluctuate. For this reason, your gross year-to-date earnings are going to be used to come up with your monthly gross income for the purpose of your loan application.
As stability is a major concern built into mortgage approval guidelines, people that work multiple jobs must show that they have consistently worked more than one job for at least two years. You also need to show that the individual jobs themselves are consistent. This means that if you work 20 hours a week at the library and 20 hours a week at the pet store, in order to count both incomes we need to show a history of holding both of those jobs at the same time for the past two years. If you worked at the library for 3 years, but the pet store only 1 year, this could cause the underwriter not to be able to consider the pet store income.
I could write more on this subject than any other, but I’ll just point out the highlights. The primary challenge I run into with self-employed clients is that their tax strategy shows very little income after all deductions are accounted for. Some businesses, especially new ones, show significant losses. In order for business income to count, it must be relatively stable…not to mention positive. We are also limited to going off of what is actually reported to the IRS. In the case of a new business, it may take years for it to show income that can be used for qualification purposes. For older, more established businesses, owners must consider the impact of their tax strategy on their ability to qualify for financing.
In general, your self-employed income will be calculated based on the average of your previous 2 years of tax returns. However, if the most recent year shows less income than the year before, we will have to use the lower number only. Remember here that the rules, unfortunately, are not designed to be fair! They are designed to protect against risk, which has definitely affected self-employed people in a big way. More than in any other category we’re talking about today, before you assume you’ll be approved for a mortgage, contact your loan officer to make double sure.
Much like business income, the challenge for landlords comes down to the tax return. Tax strategy again can conflict with your ability to qualify for new mortgage loans. One area that can cause frustration is with large repairs. If your most recent year of tax returns shows a big cost for repairs, this could impact your overall income negatively. Even if you have a primary W2 job, rental property losses are counted AGAINST this income to qualifying purposes. Also, do not assume that your leases will be used in the income calculation – tax returns will be the primary basis for this.
More than any other category, the devil is in the details here. If you have started a new W2 position, in most cases we can consider your base income for qualifying purposes like normal. Bonus income for a new job will almost never be used, however. Things get much trickier if this new position doesn’t begin until after closing. This is common for relocating executives, physicians, etc. In this case, you can only be approved for a loan based on the new income if:
- You have a fully executed employment contract. An offer letter is typically not workable without additional documentation from your new employer. The contract must explicitly state your base compensation. Projected bonus income will not be considered.
- You start the new job BEFORE your first payment is due. In most cases, you must also receive a paystub before the first payment comes due. For example, if you close at the end of May, your first payment will come due on July 1. If you do not receive a pay stub before July 1, you will likely NOT be approved for the loan. In this case, you would want to re-schedule your closing accordingly.
Do not assume anything – you will want to talk with your loan officer about all aspects of the new position as part of your formal loan application.
Keep in mind that the ‘bad’ loan programs you’ve heard about – like stated-income and no income verification loans – were originally designed for people that fit into the income categories described above. The reality of what you make can be very different than what we use for your approval. Before making assumptions about what you can qualify for, talk to your trusted loan officer…and be prepared to provide documentation as needed.