One of the pivotable points in qualifying for a home loan is your income. Essentially letting the lender know your capacity for taking on the new mortgage payment.  How you get paid will determine the documentation needed to accurately calculate the usable income for your file.  You may have a number in mind that you assume will be the amount used by the bank to determine your eligibility.   If you are an employee of a larger company and get paid a set salary every year, it’s straightforward and I would guess the number you have in mind is the correct number.  If you get paid hourly and work a set 40 hours a week, you probably also know the correct number.  These are two of the easier options when it comes to calculating income.  There are others that aren’t quite as straight forward like all types of self-employments, which include: 1099 independent contractors, schedule C filers, LLCs, S corps, and 1065 partnerships, or salary and wage earners that work overtime or received bonus income that can vary year to year.  Let’s look at each option on their own, so you can see how it differs depending on which category you fall into.

The most common is the W2 salaried wage earner or hourly employee who works the same number of hours weekly.  In these cases, the income is standardized and doesn’t fluctuate week to week or month to month, so it’s very easy for a bank to know how much that borrower will make going forward.  Consistent incomes are the banks’ favorite, as it clearly shows if the borrower can afford the new mortgage payment or not based on a very steady income level.  In these cases, we typically just need the last 2 years w2 forms and pay stubs covering the last 30 days.

What if that W2 employee works some overtime now and then or gets a bonus here or there for doing a good job?  More money is always better, right?   Yes, it is, but the bank will want to see a 2-year history of this income type to make sure it is not just a one-time event.  If a bonus or overtime has been given over a two-year period, the bank can assume it will continue in the future and now feels comfortable adding it to the base income amount for loan qualifying.   The bank will take a 2 year average of the bonus or overtime amounts and add that average to the usable income for that borrower.  The most common way to gather this information is to send a verification of employment form to the employer that separates out the different type of pay the borrower received year to year.  We can use the base income from a raise right away and no average is needed, but the overtime, bonus and commission income needs have been received for two years to be able to be averaged and included.

For all W2 wage earners the bank will use the larger Gross number (before taxes) as the amount used for qualifying.  This is an important difference than those “self-employed” of “Independent contractors” I will go over next.

For “self-employed” borrowers or those that work as independent contractors and receive a 1099 tax form and usually file a schedule C 1040, LLC 1120, S Corp 1120s, or partnership 1065… things can get a little more complicated.  In these cases, the borrower may Gross a certain amount of money each year but then write off deductions and net a much smaller number.  For example, a borrower might work as a Real Estate Agent and make $200,000 gross throughout the year, but when they do their taxes they deduct $75,000 off that number so they only pay taxes on $125,000.   For loan qualification, the bank will only use the lower “net’ number of $125,000.  On top of that, the bank will want to review the last two years’ tax returns to get an average net income for these types of borrowers.  The two-year average will be used as long as the income stays consistent or increases year to year. If the income on the recent tax return is lower than the prior year, the bank assumes there is a downward trend and will use the lower of the two years as the income for qualifying and may even want to see a year-to-date profit and loss statement to confirm things haven’t continued to decline.  The key to remember here is that for these “self-employed” borrowers the number used is the “Net” not the “Gross”.  In these cases, the borrower would need to provide the two most recent years of business and personal federal tax packages including all schedules.

One of the benefits of being self employed is having more control over your tax deductions but in the case of qualifying for a home an aggressive tax strategy can hurt your ability to qualify for the loan.   

What if someone makes a good income but writes it all off effectively showing no usable income on the tax returns?   In this case there are programs available that allow the borrower to use 12-24 months average bank deposits into a business bank account as the qualifying source of income.  A standard operating cost % is deducted from that average and the rates on these loans are usually 1-2% higher than standard conventional loans, but it is an option for borrowers in this situation.  For these programs we wouldn’t use the tax forms and will only use the 12-24 months of bank statements to arrive at the usable income number.

What about social security, pension, retirement, or disability income?  These are all great sources of income and usable for qualifying.  The key factor a bank will look at is whether or not the income source will continue for at least 3 years or not.  If the answer is yes, it will, then we can use the income to help qualify, and in some cases, we can even increase the income amount upward if it’s not being taxed.  Typically, all you need for these income types is 1. An award letter showing the monthly amount 2. proof of receipt of the income and 3. the last couple years 1099 tax forms to show the amounts received for the prior year.

What if you work more than one job, can you use both incomes to qualify?  In this case the bank has the same concerns as with overtime and bonus income.  The bank wants to know the likelihood of you continuing to work both jobs going forward.  So, they require that you have worked both jobs concurrently for at least 2 years to show a pattern that should continue once the loan is funded.

So, you can see all income is not calculated or documented the same.  It’s much easier to document income for a W2 wage earner with no overtime, but that doesn’t mean someone with a more complex income scenario shouldn’t apply or can’t qualify.  The important thing is to get the correct documents into the hands of a lending professional sooner than later so they can analyze the documents and let you know the correct income number that will be used by the banks and correctly assess the best loan program for your particular situation.  I hope this was helpful. Feel free reach out to me with any questions at brady@gtgfi.com with concerns or comments  that might help you better understand this topic.  I could write a small book on the subject but wanted to cover some basics in short form to help you understand that not all income is calculated the same when it comes to qualifying for a home loan.