Hello Mortgage Seekers!
Welcome back. Today, we are focusing on income. I have been in the mortgage business so long, looking at income has become second nature to me. When I first started in the industry, it genuinely confused me at how many people don’t know how much they make. Over the years however, I’ve seen enough various income types and structures that I finally get it – income is a complicated thing.
This is a super long topic so we are going to separate the details into three posts:
- Employment Related Income
- Side Hustle (Part Time) Income
- Overtime Income
- Seasonal Employment
- Self Employment Income
- Other Qualifying Income
Part I: Employment Related Income
Employment Related Income:
This is the bucket most people fall into. You go to work, you receive a pay check, deposit that check in the bank and you live off of those funds. Fairly straight forward huh? Not so fast young grasshopper. In the mortgage industry we use “effective income” when seeking to qualify a borrower for a new home loan. Effective income must be reasonably likely to continue through at least the first three years of the mortgage. In general, the loan office(r) must document the borrowers income and employment history and verify the accuracy of the amounts of income being reported. We can only consider income that is legally derived and when required, correctly reported on IRS tax returns.
Employment income directly refers to income derived from being an employee of a business that is reported on the IRS form W-2. To verify employment income, a loan office will ask to review at least the last two years of W2’s most recent 30 days of pay stubs and a written verification of employment. There are two main types of W-2 wage earners: salary and hourly. Slight differences are built into each earning type.
- Salaried employees – For employees who are salaried and whose income has been and will likely be consistently earned, the lender must use the current salary to calculate Effective Income.
- Hourly employees -nFor employees who are paid hourly, and whose hours do not vary, the lender must consider the borrowers current hourly rate to calculate Effective Income. If the hourly income varies, the lender must average the income over the past two years. IF, we can document an increase in pay rate, the lender can use the most recent 12 -month average of hours at the current pay rate.
One notable thing about employment income is the expected income component. If you are expecting to receive a cost of living adjustment, performance raise, new job or retirement that will be received within 60 days of loan closing, the lender may consider that income towards the home purchase. The loan office must also verify the borrower will have sufficient income or cash reserves to support the mortgage payment between loan closing and the expected increase. However, if purchasing power or debt to income ratios are a challenge, this may be the jack in the box that solves the problem.
Side Hustle and Overtime Income:
Enter the side hustle. Side hustle is a term I’ve heard in the general lexicon a lot in the last two years. It’s most commonly known as a part time job. With the advent of Lyft and Uber, it seems everyone has a secondary source of income. **Blogger note – if your side hustle is your own business, keep reading. The rules are different for non W-2 part time income** The rules on using part time income are fairly straight forward. In order to use part time income as effective income you must have held a full time and part time job, uninterrupted, for the last two years and the current part time must be likely to continue.
In my experience, this is a sticking point for a lot of people. With the rising housing prices in DC, it seems folks want to be approved for higher purchase prices. To do that, I’ve been getting lots of requests to use part time income. Guys, I say this gently, guys – you have to be able to prove you’ve held two jobs for the last two years to use the side hustle income. It does not have to be the same two jobs, but we have to be able to validate an uninterrupted two years of dual employment to use the second job.
I’m stretching a bit with the logic here, but I think the rule is written this way because it’s generally regarded as a hard thing to hold down two jobs. If you can do it for two years, and it’s reasonably expected that you will be able to continue to do the same, you can use the second income as effective income.
Overtime and bonus income is a bit of a different beast. We can use overtime and bonus income as effective income if we can prove you’ve received it for the last two years. Yes, a full 24 months is required. One important thing of note here is if the income is reduced by 20% from the last year, we have to use the current OT/bonus income. Now, how and where do we find overtime income for two years? Since the calculation requires averaging overtime and/or bonus income over two years, any loan office is going to require you provide the last pay stub of the last two years. Simply because that is the only place we can see the separation of OT/bonus income. If this applies to you, please be prepared to call HR, or data mine your employers internal website for the last pay stubs of the year so your loan officer can give you an accurate number for how much income can be counted as effective income.
I’m sure by now you see a pattern – proof of two years of income to be counted as effective income. Same thing goes here. Seasonal employment i employment that is not year round, regardless of the number of hours per week you work. Think holiday employment, summer job, winter ski instructor etc. In addition to the two year continued seasonal employment, the lender has to also verify that you are likely to be re-hired for the next season. The calculation requires the lender to average the income earned over the previous two full years to determine effective income. For seasonal income, the final pay stub may not necessarily be required, because we can use the W-2 for the last two years, in conjunction with the verification of employment. The rule here is also straight forward – if we can not prove two years of seasonal employment, we can not us it towards the mortgage.
As always, if you or someone you know is interested in a new home loan, please don’t hesitate to reach out to me, I’d love to help you with your next home purchase.