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.