For most conforming and government types of loans, a lender uses your monthly gross (before taxes) income as the basis for calculating the allowable ratio of housing expense to income. The old rule of 28/36 says that your new house payment, that includes: loan payment, taxes, insurance, HOA dues and any mortgage insurance in total should not be more than 28% of your gross monthly income and your new house payment plus other recurring installment and revolving payments not exceed more than 36% of your gross monthly income. With the advent of automated underwriting those ratios can go higher. This means you might get approved for a payment/loan amount higher than that.
If you are unsure of your monthly gross income, you can use some standard formulas that can be used to calculate monthly gross income:
Hourly wage earner: # of hours worked per pay period X hourly wage X # payperiods per year divided by 12 months = gross monthly income
Examples: Marcie works 40 hours a week and is paid every two weeks for 80 hours of work. At $22/hour X 80 hours = $1760 per pay period X 26 paychecks/year = $45,760/year divided by 12 months = $3,813.33/month gross income
Armand has an annual salary of $81,000. This divided by 12 months is $6,750/month
Shift differential, Overtime, Bonus, Commissions, Mileage and other perks count too in qualifying mortgage income
Shift Differential: When other income shows up on the paycheck, typically it can be used if there is a track record of 2 years or other evidence that it will be ongoing or is part of the job. For instance a warehouse worker who works several days a week on a Swing or Graveyard shift, or a nurse who is a charge nurse for several shifts a week are easily documentable that this is typical and ongoing. That income would be averaged separately from regular pay over the last 12-24 months using paystubs to account for the total paid out in a given time period.
Overtime, Bonus and Commissions: Lenders are looking for a two year consecutive history of receiving this pay. Fluctuations in Overtime are expected, the trend needs to show a consistency and that it is stable and expected to continue. The same would go for a bonus(es), they would need to be expected to continue and documented historically. To calculate income from these a two year average of the totals divided by the total amount of time period covered to come up with a monthly amount to be used.
Example: LaVonda is a sales rep who gets a bonus based on company performance at the end of each year. Bonuses for the past two years were $9,500 and $11,000. The total of $20,500 divided by 24 months gives her an additional $854.17 beyond her regular salary that can be used as qualifying income. If she also gets commissions on top of her salary, then her total commissions of $32,340 and $36,541 for each of the past two years that total $68,881 divided by 24 months give her commission income of $2,870.04. If her base salary is $5000/month, then based on this scenario, the amount of monthly income LaVonda has to qualify for a mortgage is: $5,000 + $854.17 + $2,870.04 = $8,724.21/month.
Special Documentation requirements for those with Commissioned income
Those with commissioned income that is less than 25% of their total annual income will provide the usual W-2 forms and paystubs for the most recent 2 year period or the lender can do a written Verification of Employment from the employer. In a case where more than their total annual income, in addition to these requirements they would need to provide copies of their most recent two years tax returns. Note that if there are any non-reimbursed business expenses, these must be subtracted from the gross commission income portion. Any major fluctuation in the income from year to year that exceeds 10% may require additional analysis at the underwriter’s review.
A second Job or seasonal and temporary work can help in qualifying for a mortgage loan
Income derived from one or more jobs may be used following the same guidelines as something that might be considered the main job. Income must have been received for at least 12 months, preferably a full 24 months. If there have been multiple employers, no gaps longer than one month will be allowed for the past 12 months. The exception to this is seasonal employment, which is also allowable.
For seasonal work there must be a two year history of the work and an average of the income will be taken. If there is also seasonal unemployment compensation this may be used if is clearly a seasonal lay off, reported on tax returns and is annually recurring. Otherwise seasonal unemployment compensation cannot be used to qualify the borrower.
Temporary employment may be considered when the borrower works through an agency or agencies and has a track record for this being a viable source of income. The work history needs to be verified for the most recent two years and work must have been steady and regular for at least 24 months. Income is averaged over a two year period of no less than 24 months. W-2’s for the last two years and recent paystub are required to document the income. Note that if the temp income is not through and agency, it will not be considered.
Calculations for Self-employed persons are similar and require documentation such as tax returns in order to do the averages. More on Self-Employed Income here.
Temporary leave and furloughs are allowed in qualifying for a mortgage loan – calculating around the leave
Short durations of absence from a job due to medical, parental, or maternity and others that are acceptable by law or the borrower’s employer may be taken into account. Regular income may be used if the borrower will return to work by the first payment date of the new mortgage. If this is not the case, underwriting will use the lesser of the temporary leave income or the regular income for income. Leave income may be supplemented by financial reservices.
Borrower would need to document employment and income history that is consistent prior to the leave and provide written confirmation of their intent to return to work when the leave timeframe has ended. A verbal verification of employment will be done by the lender and this would include confirmation by the employer that the borrower is on a temporary leave. Verification of the borrower’s regular income and any temporary leave income and verification of the duration of the leave period are required. If the leave time has already completed, a letter from the borrower and confirmation from the employer that leave was taken in a brief letter of explanation would be needed to complete the documentation for the file.
These are the more common types of income that can be used to qualify for a mortgage and how they are calculated. See Other Income Types Mortgage Calculations for more information on how lenders extract income in situations that aren’t regular employment. These may include Social Security and Retirement, Rental, Asset Management and others. Any further questions, please reach out or if you are outside the west coast area, contact your mortgage professional.
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