Getting a new mortgage these days can be a bit of a daunting task. There are so many pieces that have to all come together to make it work. As a borrower, there are five specific things that we look at to determine the overall risk of a new loan: Credit, Capacity, Capital, Characteristics and Collateral. Credit includes your credit score as well as the credit history. Capacity is your income or your means to pay back your loan and the debt-to-income (DTI) ratios that income give you. Capital is your assets, both how much you are putting into the transaction and how much will be left after you close. Characteristics are the specifics of the transactions like purchase or refinance, owner occupied vs. rental vs. 2nd home, loan-to-value and type of loan. Collateral is the characteristics of the property that the mortgage will be attached to such as value, location and type of property.
This month, we are going to take a closer look at Capacity. Gone are the days of no-income verification mortgages. A borrower’s amount and source of income must be verified to determine a borrower’s ABILITY to pay back the mortgage. How that income is calculated varies depending on the payroll structure, length on the job and number of hours worked. Let’s take a look at some of these variations:
Salaried Employee – This is by far the easiest income to calculate. The annual salary is just divided by 12 to determine the monthly average.
Hourly Full Time Employee – If you are paid an hourly wage and work 40 hours a week, your income is calculated by taking your hourly wage and multiplying by 173.33. This number is (40 hrs./week x 52 weeks/yr.)/12 months/yr. The underwriter will often compare this number to your Year to Date (YTD) income on your pay stub. If the YTD average varies drastically from the calculation, further documentation and/or explanation may be required.
Part-time Hourly Employee – While this type of employee is paid an hourly wage like the full time employee, this income is calculated very differently. Because part-time employment is not considered as stable as full-time employment, a two year history with the same part-time job is required to consider this income valid. A two year average of this part-time income is often used to calculate the monthly average but the underwriter will also look at the current wage and hours’ work and compare them to the average. Again, if there is a large variance, more documentation and/or explanations may be required.
Commission Employee – If 25% or more of a borrowers pay consists of commission, a two year history of that income is required for it to be considered valid income. Since commission is performance based, a history of an employee’s production must be used to determine the incomes validity.
Self-employed (Including rental income) – This income is calculated in a similar way as a commissioned employee. A two year average of the borrower’s tax returns is used to determine the monthly average income. There are many deductions a self-employed borrower utilizes on their tax returns. Some of these deductions are “paper losses” which means they are not real expenses. These things can sometimes be added back in to help increase a borrower’s monthly average. The most common of these add backs are depreciation and depletion.
These are the most common payroll structures that we come across but then we have variants of the above too.
New Job – If an employee has recently started a new job, this can affect the income calculation. If a borrower is a salaried employee or a salaried employee, income can be calculated the same as if they have been on the job for a long time but it will usually require more documentation from the employer and for hourly employees, the YTD income on the most recent pay stub will have to reflect the borrower has been working full time. In most cases, a borrower will have had to receive at least one month of pay (and pay stubs) to be eligible but depending on the situation, this requirement can sometimes be waived.
Bonuses, Overtime and Seasonal Income – These types of income are calculated the same as commission employees. They also have the same two year history with the same employer requirement that commission income requires.
Job Gaps – While not a source of income, a job gap can also affect a borrower’s income eligibility. Any job gap greater than 30 days must be explained. Job gaps can be an indicator that a borrower’s income may not be stable. While a significant job gap can hurt a borrower’s chance of qualifying, we have often found that as long as we have a good explanation for the job gap, we are usually able to get around this issue.
While this list is not all encompassing, it does cover the majority of situations that we see on a regular basis. If you have a question about your income and how it will affect your ability to qualify for a mortgage, give The Kunselman Team a call today at 303-578-2468.