One of the more, if not the most, important sections on a mortgage loan application is the space reserved for income. What some might not know however is how mortgage lenders view income when qualifying someone for a home loan. When a lender asks for copies of paycheck stubs for example, there’s the gross income at the top of the pay stub along with various deductions resulting in a net income amount. One might think that since bills are paid with net or “take home” income, that’s what lenders use. But that’s not the case. Lenders use gross monthly income, not net. With different tax brackets, deductions and other factors, it’s simply too much to dissect to reach a true net income amount.
When deductions are taken from gross monthly income, it’s taxes, both federal and state, that take the biggest chunk. Again, though, it’s the gross income that’s used. Lenders simply ignore the various deductions. It’s both easier that way and is applied universally. Self-employed borrowers are evaluated a bit differently but everyone else is approved in mostly the same manner. But there are types of income that is not taxable such as child support or disability pay. So how do lenders view non-taxable income if not taxes are taken out? What’s the gross amount for non-taxable income?
Lenders “gross up” non-taxable income in an effort to put taxable and non-taxable on a level qualifying field. For example, an employee makes $5,000 per month. That’s the amount used to qualify. There may be other types of income that does not come from an employer that may also be taxed. Part time income, dividends and interest payments and bonus income can be taxed. The loan application has fields where these and other types of taxable income are entered. The amounts are added together to reach a qualifying income amount. Now let’s look at non-taxable income.
Conventional loan programs, which account for nearly two out of every three loans originated in today’s market, can have non-taxable income grossed up by 25 percent. Note, lenders have the ability to increase the amount by a lesser percentage but cannot exceed the 25 percent number. For instance, an applicant receives $5,000 per month in non-taxable income. But that’s not the amount lenders use for qualifying. Instead, the lender takes a multiplier of 1.25 to obtain the amount used. In this example, it would be $5,000 x 1.25 = $6,250. Grossing up the non-taxable income places it on par with taxable.
This is important because those who do receive non-taxable income often use this amount when applying for a mortgage. A 25 percent increase in non-taxable income is a considerable bump in qualifying income. This type of income must also be evaluated just as with any other type of income. Qualifying income must have a two year history and it must be consistent. A determination is made whether or not the income will continue into the future. If these factors are met, the income may be used. A non-taxable inheritance for example could not be used be used for example because it’s a one-time event.
Finally, if there’s any question about qualifying income, it’s important to speak with a mortgage loan officer before applying. The loan officer can provide you with a qualifying amount over the phone after a brief conversation over the phone. From there, you can be provided with a prequalification which gives you an idea on what you might qualify for.