How Lenders Calculate Qualifying Income
Assuming you have good credit and assets to buy a home, the most important factor in qualifying for a home loan is your debt to income ratio.
Your debt to income ratio, or DTI, determines how much home you qualify for, and it all hinges on how the lender calculates your qualifying income.
What you have to be aware of, is that not all of your income can be used to qualify you for a home mortgage.
This can be quite frustrating because even though you earn the money, and you can use it to pay your house payment, you cannot use it to qualify to buy the house.
How Do You Get Paid?
This is the first question your loan officer will ask, how do you get paid? When you are asked this, basically, there are several things we need to know:
- Are you paid a straight Salary?
- Are you paid hourly? How many hours do you work?
- Are you full time or part time?
- Do you have a second job?
- Do you work overtime?
- Do you receive bonuses?
- Is more than 25% of your income from Commission?
- Are you self employed? What kind of business? (ie..Corporation, sole proprietor)
- Do you itemize your tax returns?
- Do you write off 2106 expenses?
- Do you own rental properties?
The answer to any one of these questions can change the way that your income is calculated.
Common Qualifying Income Challenges
Here are some of the most common challenges that you can encounter after your lender begins going through your income documentation.
Overtime and Bonuses – Overtime is great when you can get it, and in order to use it to qualify for home loan, you have to document that you’ve been receiving Overtime for 2 years. Once you determine that you can use your overtime, it is then averaged over the 2 years. Bonus income is treated the same way as overtime.
Part Time Job – Having a part time job is a great way to supplement your income and help make ends meet. Part time income is looked at similarly to overtime and bonus income. You have to document 2 years of receiving a second source of income, averaged over 24 months.
Schedule C – It is not uncommon to have a part time, or home based or consulting business. It is also not uncommon that there will be losses generated, and used to offset taxable income. Your qualifying income is calculated considering any schedule c losses, or income.
Commission Income – This is another one of those tricky situations. If 25% or more of your income comes from commissions, it is treated similarly to overtime and bonus, requiring a 2 year history to use it toward your debt to income ratio.
Avoiding Income Surprises
There’s no way to avoid the calculation method required for you to qualify for a home loan, but you can certainly avoid surprises when preparing yourself to buy a home.
Get Pre-Approved – before you start shopping for homes. I feel like I say this same thing over and over again, do not make offers on homes unless you have an approval from a lender.
If your lender offers you a Pre-Qualification letter based on a phone conversation, get another lender. While there are certainly scenarios where you are salary, or straight W2 with no deductions, for anything described so far, you need a lender to pull out the calculator and take the time to give you an accurate purchase price limit.
Expect 24 to 48 hours for challenging income scenarios before you might have an answer. When you’re Pre-Approved with an an automated underwriting approval, you have the tools necessary to confidently make offers to purchase within your approved price range.
Manage Expectations – Is so important during this process, you cannot be too cautious, or careful. Ask lots of questions, and make sure you’re being told the truth, and not just want they think you want to hear.
Timeliness are a pivotal factor in the escrow process. Understanding the timelines, the deadlines, the requirements as agreed to in the Residential Purchase Agreement (RPA), in addition to the lender’s underwriting conditions. By understanding all the moving parts, and interested parties, the process can be much more “surprise free”, which is ultimately your goal.
Timely Communication – Is an absolute deal breaker. It’s important that your lender be available in a reasonable amount of time with little effort to answer questions during the loan approval process. It’s important that you respect, and understand the timelines (manage expectations).
Going through the entire underwriting process is a very thorough, and detailed process. It is vitally important that you get