What Mortgage Can I Afford?
So let me get this straight; you make $300,000 annually, but you show Uncle Sam that your income is below the poverty line? Sure, no problem, let’s get you that 2nd home on the beach!
Yes that example may be a little extreme. However, this is something that constantly comes up with potential homeowners. In Part 3 of the “keeping your home loan process simple” series; the income piece of the mortgage puzzle is laid out in plain text.
Here is the short of it: Show a recent 2 year consistent income on your tax returns, and prove you’re still receiving that compensation. There you go, no need to keep reading, unless of course your circumstances aren’t quite that simple.
The truth is that even if you’re a salaried employee with a fortune 500 company; in some cases it can still be a challenge to prove your income, and how you’re compensated. This should help you answer the question “what mortgage can I afford”.
Income basics
recent 2 years W-2s (1099’s if applicable), and most recent 30 days worth of pay stubs. You may not always be asked for your tax returns, but it’s best to provide them up front in order to reduce any last minute surprises.
- Pay stubs should show: the same employers name or entity as the W-2, your name, taxes withheld, and pay rate.
- If you are using overtime, bonus, or special incentive pay to qualify your employer will need to break down that pay separate from your salary (or hourly) pay. They will also need to confirm in writing how much of that type of income you have received in the last 2 years, and how much you’ve received so far in the present year. This helps the lender to gain an understanding of how consistent, and stable that income has been for you historically.
- For commission income you’ll need to provide a 2 year history as well. Additionally, your tax returns will get examined in more detail to confirm you didn’t have any employment writeoffs which may offset your income. This can be more common with commission folks.
- Your lender will order your tax transcripts from the IRS. The purpose is to verify that the IRS shows the same figures as the tax returns you provided.
Self-employed
Debt-to-income ratio
Your monthly liabilities divided by your monthly verifiable income equals your debt-to-income ratio. The liabilities that are considered in this figure are the payments shown on your credit report, property insurance/taxes, alimony/child support owed, and any other legally binding payment. It’s best to do what you can to put yourself in a position to be at or below 43% debt-to-income ratio.Example… Mr. Homeowner has a car loan and credit card; combined payments are $250/month. His mortgage payment including taxes, insurance, and mortgage insurance is $1,100/month. Mr. Homeowner is an engineer with a $60,000/year salary. Mr. Homeowner’s debt-to-income ratio looks like this: 1,350 / 5,000 = .27, or 27%.Beyond basics
Investment income and capital gains – 2 years most recent federal tax returns. Your lender will evaluate consistency, and likelihood of continuance.
Alimony/Child support – You’re probably shocked, but some ex-spouses fail to pay court ordered alimony or child support. For that reason you’ll need to show proof you have been receiving consistent payments for at least 6 months. Also have the full divorce decree ready, and any other updated court documents addressing any changes.
Social security retirement – Current year award letter from social security which states the amount of monthly compensation you’re entitled to. Also a good idea to provide 2 months bank statements showing the deposits received from social security.
Social security permanent disability – If social security has deemed you to be permanently disabled you will have an award letter confirming such compensation. You may also be required to provide a recent letter from a physician confirming
the state of your condition and the likelihood of the condition to change.
Short term disability – Short term disability will be most likely ineligible to use to qualify for a mortgage because of the uncertainty of continuance.
Pension/retirement – Some pension plans will provide a pay stub and W-2; similar to what you received when you were working. If so, that should be simple enough to verify. If you’re receiving income from an annuity, IRA, or 401K you’ll need to prove it. It would be a good idea to have your most recent quarterly investment statement handy; along with 2 years tax returns. The investment statement you provide will help track your draw (income) history, but also give an indication as to how long that income is likely to continue. The remaining balance should be at least enough to sustain the same draws for 3 years.
VA disability – After being discharged from the armed forces; a veteran may be entitled to disability compensation for injuries sustained while in service. Similar to social security disability; you’ll have an award letter issued to you stating your compensation benefits. The VA has gotten much better in the last few years on requests for a new letter or verification of the status. More on VA and veteran benefits coming soon.
Unemployment – Typically, if unemployment is reported on your tax returns you’ll need to explain in writing why you were receiving unemployment. If you’re in a seasonal line of work like landscaping, and you cannot work in the winter, that would be considered reasonable reason to consider using unemployment income to qualify. If you lost your job and couldn’t find employment for a year; the unemployment compensation you received at that time wouldn’t be considered as stable.
Part time – You must demonstrate a 2 year history receiving consistent hours and pay.
Higher education – You can use the time spent while in college or trade school as part of your 2 year history. The time in higher learning will be considered if you can provide transcripts or a diploma. If school is part of your 2 year history; the only income considered for your new employment will be salary/hourly income in a full time position.
Under the table – Waiters and bartenders tend to not claim all tips received on their tax returns. Any job that you have that is paid under the table will not be considered.
Letters of explanation – When your situation is unique, and you have an opportunity to tell the story, take that opportunity seriously. Be detailed in why it took 4 months to find a job, or why your relocation to another state will not have a negative impact on your income. You’re painting a picture for your lender. You’re helping them put together the puzzle.
Verification of employment – Your lender will reach out to your employer to make sure you actually work there. While your loan is in process, and right before closing your loan your employment status will be verified. This is also an opportunity to have your commission, bonus, or overtime income verified. Things can get sticky if your employer refuses to break down your salary income from other compensation in detail.
What’s the name of the game? If you said consistency coupled with stability; you’d be dead on. Of course the ability to provide relevant documentation to support everything puts the icing on the cake.
A few tips to end with for now…
Your tax returns show unreimbursed business expenses on you schedule A. Take a look at those before you turn your tax returns in to your lender even if you’re not a business owner. A mechanic at a dealership could claim unreimbursed expenses for uniform costs throughout the year. Often times unreimbursed business expenses can cause a last minute issue if they are initially overlooked. Claiming that type of write-off could have an impact on your debt-to-income ratio.
If you have taken out a 401K loan against your employer’s retirement plan there will be an item on your paystub that with address that. Since it’s a loan you’re paying back, that liability would have to be considered in your debt-to-income ratio. If your total vested balance in the 401K exceeds the amount of the loan you have against it; you may be able to exclude that liability from your debt ratio. Have your most recent quarterly statement handy to show your balance.
Having the last pay stub (December 31st pay stub) for the previous two years will often be an easy way to verify how much bonus, commission, and overtime income you received in the previous years.
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What questions do you have?