5 Types of Income Mortgage Lenders Will Consider

The newest lending guidelines require that you have more income compared to what you owe every month. Knowing what types of income a mortgage lender will use is more important than ever.

Jul 19, 2014 at 6:31PM

The newest mortgage lending guidelines require that you have more income than what you owe each month. A low debt-to-income ratio is crucial, so it's more important than ever to know what types of income mortgage lenders will factor into that equation.

Here are five types of income that you'll want to report to your mortgage lender if applicable.

1. Overtime income
Working overtime can either help or hinder in the mortgage approval process. If you have consistently worked overtime over the past two years and are still getting the same amount so far this year, then this income can be considered. If there has been a sudden drop, or even a sudden spike, in overtime hours, it may be less likely that overtime will help, and it could even be a red flag to the lender that your employment situation is unstable. Make sure you know someone in HR who can help out with an explanation, because any fluctuations in this type of income will need to be explained.

2. Investment income
Using income from IRA distributions or dividend interest can get tricky these days. The general rule is that you must have been receiving it for at least two years, and it must continue for at least three more. There are some cases where you can start taking a distribution, and so long as the arrangement is in writing and you have received a few months' worth of payments, you'll be able to use this to qualify for a loan. Dividend and interest income is always averaged over a couple of years, so make sure you have all the schedules of your tax returns ready. 

One big caveat to capital gains income: It's almost never usable for qualifying purposes anymore. If you're a real-estate investor, even if you have a history of buying and selling properties every year, it's not likely to be considered a qualifying source of income.

3. Nontaxable income
Social security, pensions, and other forms of employer retirement income have an added bonus: the gross up. In most cases you get an extra $250 worth of loan qualifying power for every $1,000 of nontaxable income you receive. This can make a huge difference in qualifying for a loan. The basic idea is that because lenders use gross income to qualify people who have taxable income, someone who has nontaxable income has more spending power, as no taxes are being taken out.

Here's a quick example. Assuming you receive $2,000 of nontaxable social-security pension, without the gross up, you could qualify for about a $130,000 loan for a 30-year fixed-rate mortgage at current rates. 

But grossing up that income 25% gives you $2,500 per month of qualifying income, which means your loan-qualifying maximum just went up to about $170,000.

If you are still in an active-duty or civilian military position, some of your income may be nontaxable -- be sure to have a copy of your pay stub for your mortgage professional so he or she can review it for items that can be grossed up. Child support is also nontaxable so long as you can prove you've been receiving it consistently for the last 12 months and the decree shows that it will last at least three more years. 

4. Unemployment income
You might be surprised to learn that unemployment income is a valid source of income when applying for a mortgage. Seasonal workers -- i.e., people who who earn the bulk of their income during a particular period each year, such as the holidays or an agricultural season -- will often have regular periods of unemployment. So long as the income earned and the time periods are fairly consistent, seasonal income and unemployment income can be used to get a mortgage. 

5. Self-employed income
Self-employed borrowers often feel picked on these days. During the stated-income heyday, it was a lot easier to get a loan, because tax returns didn't need to be analyzed. If you're unfamiliar with "stated income," the basic idea was that you could write down any income, without verification by the lender, and if your credit score was high enough, you got a loan. Originally designed to help self-employed borrowers avoid the hassle of providing truckloads of tax returns, the program began to be offered to customers who had fixed incomes -- and then, eventually, to anyone with a pulse. People with entry-level jobs in the hospitality industry were "stating" six-figure salaries and buying huge houses. When values dropped, these same customers couldn't sell their houses at a profit, and a tsunami of foreclosures began.

Many self-employed borrowers qualify without stated-income loans. Unfortunately, the pool of mortgage sales people who know how to analyze returns is very small, as many of them started in the business during the "fog this mirror and you get a loan" days. Ask your mortgage professional if he or she has experience analyzing tax returns. If not, you aren't likely to get a fair shot at a loan approval.

Foolish final points
Make sure you provide information about every source of income you receive, no matter how insignificant you think it is. You'll need to have a contact in your human resources department available to write up a letter of explanation or fill out a verification of employment form if your income has a lot of bells and whistles that aren't obvious on your pay stubs or W-2s.

If you don't get approved for the amount you want, consider that you may be getting approved for the amount you need to buy a house you can actually afford.

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