Employment and Income Calculations for a Mortgage
In order to qualify for a home loan, standard ratios are applied to the borrower’s income and debt payments. For conventional conforming mortgage loans the standard ratios are 32% and 38%. To calculate these debt ratios the mortgage lender needs to measure the borrower’s debts and income.
The first debt ratio measures borrowers new monthly mortgage payment divided by gross monthly income. The second debt ratio measures the monthly mortgage payment plus all other contractual monthly payments divided into the gross monthly income. These two debt ratios are often referred to as the front end ratio and back end ratio in the mortgage lending industry.
When applying for a home mortgage, a borrower should not only be aware of these debt ratio requirements but how they are calculated. When these debt ratios are calculated, one of the hardest measurements to calculate and often improperly calculated components is the borrower’s gross monthly income. What appears to be a simple calculation is often made difficult because of the borrower’s employment history and income fluctuations as well as guidelines that are mandated by the mortgage industry.
The anticipated amount of gross monthly income and likelihood that it will continue must be established to determine a borrower’s capacity to repay a new mortgage loan. Income that can not be verified or will not continue or is not stable, can not be used to calculate debt to income ratios on a mortgage loan request.
Gross monthly income will be checked by the mortgage lender for consistency and continuity. Once a stable income and employment position is considered acceptable, the mortgage lender will need to calculate gross monthly income based on historical pay and employment verification. Standard income is calculated by analyzing the average income and hours worked as well as the contractual relationship with the employer.
If the mortgage loan borrower is paid twice a month, then the gross monthly pay from the two most recent paychecks is added together to determine monthly income. If the borrower is paid every other week, then the gross bi-weekly paycheck is multiplied by 26 then divided by 12 to determine the monthly income figure. If the home loan borrower is paid weekly, the weekly gross pay is multiplied by 52 then divided by 12 to determine gross monthly income.
Mortgage loan applicants that have stable income with set employment contracts are the easiest gross monthly income calculations for the mortgage lender. For example; a school teacher that is paid a $60,000.00 per year should have a w-2 from the previous year that reflects that income amount and pay stub that confirm and monthly income amount of $5,000.00.
However, a construction worker that is paid $25.00 per hour may or may not be as easy a calculation to determine the monthly gross income. If the worker is consistently working a set number of hours per week, the gross monthly income is achieved by multiplying the hourly wage by the number of hours worked per week, which is then multiplied by 52 weeks and divided by 12.
If a mortgage applicant receives overtime or bonus income the income can be used to qualify for the home loan with restrictions. The borrower must have received the bonus or overtime income for a period of at least two years and the income has to be determined as likely to continue at the average rate of the past two years.
Part time or seasonal income may be used to qualify for a home loan if the income has been earned for a period of at least two years and is likely to continue.
Commission income can be included if it has earned for a period of at least two years and will be determined by the mortgage lender based on an average of the past two years income. If the commission income shows a decline over the two-year period the mortgage lender may deny the inclusion of the income to qualify for the mortgage loan request. Commission income that has not be earned for more than one year will generally be excluded from gross monthly income calculations.
A borrower may qualify for the home loan request if they have earned commission income for less than one year but have earned income not including commissions that would be sufficient to qualify the borrower for the mortgage.
Commission income must be verified with two years of signed federal income tax returns along with one month of current income pay stubs. Any business expenses or unreimbursed business expenses declared on the tax return will deducted from the gross pay calculations.
Unemployment income may be used as qualifying income for a home loan request if the income is recurring and consistent. The test for recurring and consistent income is documentation of two years history in income and reasonable belief that the income will continue. Examples of recurring unemployment income includes seasonal workers or recurring factory layoffs.
Any income earned that is legal non taxable income may have the savings that would have been paid as tax added back into the monthly gross income calculations to qualify for the home loan request. The process of adding income to non taxed income sources such as social security income is referred to as grossing up the income in the mortgage lending industry
The amount of income that can b added to the regular income that is not subject to federal income taxes must not exceed the appropriate tax rate for that income amount. The mortgage lender must document and support the additions to the income. The mortgage lender should use a tax rate that is appropriate for the borrower’s income level and should not be greater than 25%.
Projecting future income to qualify for a home loan is not allowed. Projected raises or self employed income that has not been documented can not used for qualifying purposes.
There is no established limit regarding the amount of time a home loan applicant has to have on a job to qualify for the home loan. The mortgage lender is generally required to verify the home loan applicant’s most recent employment covering the past two years. Gaps or periods of time of unemployment does not mean that a borrower will declined for the mortgage loan request but employment gaps should be explained and documented.
Although a home loan applicant will have to document gaps in employment that are longer than one month, seasonal unemployment is an acceptable source of income, recent school graduation is acceptable.
Frequent job changes that are either lateral moves or advances in income and position are not considered high-risk employment and income situations. But, the mortgage lender is required to document or assess the probability of continued employment which can either be accomplished in writing or determined by reviewing the previous to years employment and income history.
Home loan applicants that have recently returned to work after a prolonged absence from the work force may pose a problem for the mortgage lender to consider the total monthly gross income of that borrower. The mortgage lender will generally try and document a two-week employment history that excludes the long employment gap and will usually require six full months of income on the new job.
Standard employment verification procedures for new home loan applicants will generally entail a process of validation that is dependent upon the source and type of income the borrower obtains.
Salaried borrowers will generally need to supply to the mortgage lender the borrower’s most recent two years W-2’s and pay stubs that cover a 30 day periods of time. The mortgage lender will generally verify employment by phone or in writing if sufficient data is not obtained over the phone.
Overtime and bonus income must be verified with two years W-2’s and a written employment verification to ascertain the rate of previous bonus and /or overtime income and the likelihood of that rate continuing.
Child support or alimony may be used to qualify for a mortgage loan. The mortgage lender will be required to validate the divorce decree and the borrower will have to supply at least three months of canceled checks verifying receipt of the income. Child support, alimony and social security that is not received for those of retirement age must be verified to continue for at least a period of three years into the future.
Social security income and pension income is often paid to individuals by direct deposit. These sources of income will be verified by reviewing the bank statements in which the funds are direct deposited. These sources of income will generally be verified by the sender with annual awards letters. The mortgage lender will request a copy of the most recent annual award letter as well.
Rental income will need to be verified with tax returns and leases. The average of the last two years of net rental income will be used as the monthly income figure. Often, this figure is negative since many rental properties generate a loss for the owners that can be used to offset other taxable income sources. Unfortunately, the only help in overcoming the loss is to add in the depreciation charges that may be on the tax return for the property to calculate an adjusted gross rental income amount.
A mortgage loan borrower that owns more than 25% of a business is considered self employed on most all mortgage programs. Self employed borrowers will have to two years of corporate tax returns f the business owned is a schedule C or S corporation. If the borrower runs a sole proprietorship, two years of personal income tax returns will be needed.
Understanding the needs of the mortgage lender to calculate and verify income will help a borrower understand the mortgage loan approval process and expedite that approval.
Using a Mortgage Loan for Debt Consolidation
Cash out refinance transactions for debt consolidations is a popular mortgage transaction. Cash out refinances represents a large portion of mortgage refinance transactions each year. For consumers that own a home and have a fair amount of consumer debt, a cash out refinance for debt consolidation purposes is well worth considering.
Sometimes a person can get into debt problems without much effort at all. Perhaps you have even experienced credit problems and are showing various signs of damaged credit do the debt overload. If you are willing to be disciplined, in a serious fashion and you own a home, one way out may be a cash out refinance to consolidate these debts. This may help you solve your credit and debt situation despite some of the inherent risks involved with such a home loan.
It may be possible to refinance your mortgage that you currently have with a loan amount greater than the existing loan balance. This is called cash out refinance. The extra money obtained from the new refinance transaction can be used to pay off other bills and debts. A cash out refinance for debt consolidation loan gives the home loan borrower money to pay off their existing debt, resulting in just one monthly payment and quite possibly a lot less stress. With discipline, this home loan makes it much easier to manage your budget since you only have to worry about a single monthly mortgage payment schedule. This type of refinancing option means you will pay a longer term and subsequently more mortgage interest over the life of the debt.
When applying for refinance for debt consolidation, make sure you explain this to the mortgage lender and loan officer. During the qualifying process for a refinance, the debt ratios the mortgage lender will evaluate are as if the new mortgage loan is in place. When this mortgage loan is for cash back to pay off consumer debt the application will not consider the existing payments of the debt being paid off to calculate the debt ratios.
The three key factors in evaluating your loan request will be the debt ratios, the loan to value and your credit report. In order to make sure the debt ratios are not excessive, it is important that the mortgage loan application does reflect the debts to be paid off otherwise the home loan application could result in a loan denial for an excessive debt ratio.
When you consolidate various high interest rate debts into one mortgage loan the results can be very attractive and appealing. With a debt consolidation mortgage, you do not have to pay different interest rates to creditors, or pay your creditors at different times of the month. A debt consolidation mortgage refinance combines your debts into one loan payment a month, one that you should be more manageable.
Since mortgage loans are secured by real estate, the interest rate or mortgage rate is generally much lower than that of credit cards and personal loans. And in most cases, the interest paid on a mortgage is tax deductible. With discipline, you can now budget better to increase savings or prepay on the new refinanced mortgage and extinguish all of your debt early.
Be careful; do not use the freedom of lower monthly payments to avoid getting your financial house in order. Do not increase in your unsecured debt after you consolidated through a mortgage refinance. Pay strict attention to your financial outlays and use the home loan to improve your financial health.
Benefits of a cash out refinance for debt consolidation include:
The ability to take all different types of high interest loans and combine them into one lower interest mortgage when you enter into a refinance. This pays off the higher interest debts.
Improves your credit rating by reducing the amount of outstanding debts per account.
Most mortgage loans allow prepayment without penalty, allowing the borrower to have the option of not only consolidating many consumer debt payments into one but also to pay a higher monthly mortgage payment if they choose and reduce the total debt early.
By paying off debts that may have been outstanding, you stop and eliminate debt collection activities, foreclosure, bankruptcy, and other potential negative actions that affect your overall credit status.
The process to get a debt consolidation mortgage is fairly simple. Research and shop around for repayment plan that meets your budget and risk, and find the lowest mortgage rate and closing costs that you can. Be cautious before signing anything and make sure you understand all the repayment terms, mortgage rates, and costs of the refinance transaction. Use the mortgage calculators to evaluate the mortgage rates and mortgage payment options.
Using a cash out refinance mortgage for a debt consolidation can make sense, and help overcome severe debt problems, but it does result in higher interest and higher fees. It will take discipline to make sure the new payment amount is handled in a timely fashion. You will have a longer mortgage term and pay more over the length of the loan. It is often smart to restructure your debt this way, but this does result in a larger single debt amount. For this reason it’s smart to investigate shorter-term mortgage options to try and avoid paying a larger amount of money over time.
Q. If I am concerned about getting approved for a mortgage loan, what should I do?
A. Of course, the first answer is to do your research. The number one way to help the mortgage loan approval process is to be prepared and understand how the mortgage loan process unfolds.
This may sound too simplified, but with the creation of credit scores and automated underwriting, the home loan approval process is based on the analysis of a series of numbers. Numbers such as, the amount of the down payment, the loan to value ratio, the borrower’s credit scores, debt to income ratios and more are all quantified and evaluated to come up with home loan approval or denial.
What is not included is subjective analysis. Number based assessments help to eliminate discrimination since color and race is not part of the input process. But, numbers can also hurt those borrowers that fell on tough times and are now putting their financial house in order. The mortgage loan approval and application is based on your debts, income, assets and credit at a point in time. Another words, you are approved or denied for a home loan based on your credit and income and other figures today, not where you will be tomorrow.
Mortgage lenders use an automated underwriting program, usually the one’s established by either FNMA of FHLMC, and input data about your current financial situation including your credit, income, debts and assets into these systems. Taking all the necessary information, the mortgage lender determines mortgage affordability. The key to any one individuals loan approval is be prepared and have the prettiest set of numbers for the mortgage lender to input in the automated underwriting system.
One of the most important numbers input or evaluated by the automated underwriting program is the borrower’s credit score. The credit score is one of the primary indicators of your ability to repay the mortgage loan, so it’s a good idea to know it before you apply with a mortgage lender. For the most part, if your score is above 760 you can expect to get the best mortgage rate a mortgage lender has to offer; if your score is below 660 you may have trouble getting approved until you improve your credit and credit score. You can obtain a free copy of your credit report annually at www.annualcreditreport.com.
Debt ratios are another key number quantified by the mortgage lender. Debt ratios are simply a measure of affordability. Debt ratios are measurements of affordability expressed as the percent of a borrowers income used to pay for debt. Mortgage lenders want to make sure a borrower’s monthly mortgage payment does not exceed 28 percent of their income before taxes. The mortgage lender will also look to see that total monthly debt payments including the mortgage payment, car payments and credit cards doesn’t exceed 36 percent of total gross monthly income. These two debt ratios are referred to as the front end and back end ratios in the mortgage industry.
Do the math calculations on your own with one of the mortgage calculators to see how your debt ratios stack up against these guidelines. The web site, www.selectcalculators.com is great site for mortgage calculators. If your proposed housing expenses or monthly mortgage payment is greater than 28% and total debt payments, car loan, student loans and other loans, is greater than 36 percent of your gross income, you may have trouble qualifying for new home loan. In tight situations, you may want to see is if there is a way to reduce some of those monthly debt payments before you apply for a home loan.
The down payment, assets and loan to value are all related measurements. The loan to value measure the loan amount in relation to the value of the home. An 80% loan to value mortgage equates to a home loan that 80% of the home’s value. For a purchase transaction, which would mean the borrower is putting 20% down or a 20% down payment.
The assets the mortgage lender is evaluating are the funds held by the borrower needed to cover that down payment, closing costs and reserves. The reserves are a measure of funds left over after paying for down payment and closing costs as a cushion or safety net. At least two months reserves will be mandatory. This is defined as two months worth of monthly mortgage payments. More reserves will make the home loan approval easier. Once again, the mortgage calculator and a look at your own finances can tell you where your loan to value will be as well as the number of months of monthly mortgage payments you have in reserve.
All of these numbers, debt ratios, credit scores and loan to value are evaluated by the mortgage lender via the automated underwriting program. The better any of the numbers are the easier the home loan approval process will be. Really high credit scores will be approved with less paperwork than lower scores. Larger down payments are processed faster. Low debt ratios will facilitate the approval process as well.
In a perfect world you want to save for a large down payment, improve your credit score and lower your debt-to-income ratio. But, in light of that, you may simply want to know where your weak spots are regarding these factors and see what you can do to improve on them before you apply for new mortgage loan. This is a good rule whether you are applying for a purchase or a mortgage refinance.