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Income and employment

How a lender evaluates your income and employment status is not always straightforward, especially if you receive income from your own business, investments, real estate, alimony, or partnerships.

Income is a primary factor in determining the size of the loan you qualify for. The debt side of the debt-to-income ratio is straightforward: lenders generally use the monthly payments for your existing debt that are listed on your credit report and add an estimate of the new monthly housing expense (mortgage payment + property taxes + insurance or HOA dues). However, the underwriting guidelines which determine how a lender will look at your income can vary sharply depending on the lender and/or the loan program you have chosen. Unless you have a stable, salaried income, without bonus or commission, it’s best to run your situation by a lender.

Important notes about income:
  • For self-employed borrowers who report their income on Schedule C, lenders primarily use net income, after all expenses, which can be a problem for self-employed borrowers with extensive write-offs.
  • Investment income has to have a history of at least two years.
  • Rental income used for loan qualification can vary from the rental income shown on Schedule E because of depreciation, income history, and other issues.
  • Alimony generally needs at least a six-month history of timely receipt and needs to continue for at least two additional years, as laid out in a settlement agreement.
  • The use of partnership income to qualify is governed by a web of rules; ask your lender.

 

About employment status:
  • If you receive a W-2, you are considered an employee, unless you own more than 25% of the company that employs you.
  • If your primary income is reported on either Schedule C or Schedule E of your federal tax return, you are considered self-employed.
  • If you own more than 25% of the company that employs you (even if you receive a salary and a W-2), you will need to provide the two most recent corporate tax returns with your loan application.
  • If your partnership interest is greater than 25%, as stated on the most recent K-1, you will have to provide partnership tax returns.
  • If you are an investor with at least a three-year history of investment income—dividends, interest, and/or capital gains—or a two year history of receiving rental income, you will be asked for supporting documentation showing that your income is likely to continue.
  • If you are a self-employed business owner or member of a partnership, you will have to provide a simple profit and loss statement for your business or partnership to cover the period since your most recent tax return was filed. This normally does not have to be prepared by an accountant. Your lender can give you guidelines on what exactly you will need to provide, depending on your particular situation.

 
Most problems with employment status usually concern self-employment. Most lenders require proof of self-employment going back at least two years, although there may be some exceptions. Consistency is important: a doctor who has gone from working in a hospital to opening a private practice, or a corporate IT manager who is now a computer networking consultant, are looked upon more favorably than a software engineer who has become a real estate agent, or a flight attendant who has become a landscaper.

Most lenders will accept one of the following as proof of self-employment:

  • Copies of the two most recent business licenses issued annually by the city or county in which your business is located
  • A letter from a CPA who has been preparing your taxes for at least two years and will state that during that time you have been self-employed filing an appropriate tax schedule for your business type

If you don’t have a business license and your tax returns are self-prepared, alternate documentation may be an option – for example, letters from two clients who will state that they have worked with you for at least two years.

There are no more ‘stated income’ loans. New regulations require that lenders verify that you have sufficient income to make the loan payments. There are loan programs that will impute income from your liquid assets, from retirement assets if you are retired or at retirement age, and a few that impute income for self-employed borrowers based upon cash flow as demonstrated on business bank statements.

If you are uncertain how a lender will look at your income, a good mortgage broker should be able to accurately assess your situation and give you options, as well as the perspective that comes from working with many different lenders. It is very important that your lender has all of your income documentation very early in the process, so that there are no unpleasant surprises down the road.