As mortgage professionals, we are determining the income we can use to qualify borrowers for mortgage financing every day. There are three major entities who purchase mortgage backed securities, Fannie Mae, Freddie Mac, and Ginnie Mae. Fannie Mae and Freddie Mac set the rules for Conventional financing and Ginnie Mae for loans insured by the Federal Housing Administration (FHA) and loans guaranteed by the Veteran’s Administration (VA). While each program has different subtleties they basically treat income in a similar fashion.
Each of the lending programs use the gross wages for W-2 wage earners when calculating the income borrowers can use to qualify for mortgage financing. This is the income before any deductions for taxes are taken out. Lenders use the borrower’s current income for salaried employees and hourly employees who work at least 40 hours per week. Some employees work less than 40 hours per week and in this case, we generally average their income over a 24-month period. There is some flexibility with this time-frame taken on a case by case basis. Generally, we will average other types of employment income over a 12 – 24-month period. These include, bonus, overtime, piece work, and commission to name a few.
Self-Employed borrowers are normally required to provided their latest 2 years personal and corporate income tax returns. In some instances, Freddie Mac and Fannie Mae will approve borrowers using the most current year’s income tax returns only. These approvals are largely based on the length of time the borrowers have been self-employed and the borrower’s credit rating. The net taxable income is used to qualify these borrowers for mortgage financing, and is averaged over the one or two-year period. The lender can add back some expenses which are not out of pocket expenses such as amortization and depreciation when calculating the income used for qualification.
We find that numerous borrowers have non-employment income, such as social security, pensions, alimony, child-support, and various other types of income which is from sources other than their work. In these cases, we are required to show that the income is being received, the amount being received, and the duration of the income. It must continue for at least 3 years into the future from the time the borrower closes on their mortgage loan to use it for qualification. We can use income that IRS considers non-taxable income, but we cannot use income which is supposed be taxed but is not reported to the IRS.
Buyers who own rental properties can use the net rental income toward qualifying for a new mortgage loan. They must provide a copy of their income tax return to prove the amount of the rental income. They can provide a copy of the lease agreement if the property was acquired after their latest income tax return was filed with the IRS. In these cases, the lender will use 75% of the rent to consider expenses that will be incurred during the year. Rental income from the subject property being financed can be used toward qualification. The lender will obtain a rental schedule on the appraisal and use 75% of the gross rental income, again to consider expense that will be incurred during the year.
All in all, mortgage lenders can use most income sources if they are verifiable through a third party and are considered a stable source of income. In addition, new lenders have been entering the market with programs using bank deposits to verify income for self-employed borrowers. They even have programs that use the rental income from investment properties instead of other sources of income the qualify borrowers. While these programs are available they require larger down payments, and have less than attractive terms with regards to rates and fees.
The mortgage market is constantly moving with programs coming in and out of the marketplace. The best way to find out your purchasing power is to contact a trusted mortgage loan originator who can review your credit, income, and assets to determine your best path to finance your next purchase or refinance an existing loan.