I have often written about the different parts of the mortgage loan process and the components that are needed for a full approval. Yet, it’s been a while since I can remember focusing on just income. So, let’s all take a peek into the basics of qualifying income—Including you well-educated higher income earners, because a big part of this is for you.
Qualifying income for a full loan approval must be verifiable.
Verifiable means proving both past and future income. To verify your income, it takes only a simple form. The very basic form is used in conjunction with a W2 or paystub from someone who may work a standard forty-hour work week for a large corporation—over the past two years. This type of income is often the easiest to prove for both the past and future with the mix of W2’s, paystubs, and a what is called a VOE.
A VOE is a verification of employment, signed by the persons employer or third-party verification system. The VOE includes probability of continued employment and income for the next three years, allowing an easy verification for your qualifying income. These ingredients to verify your qualifying income is what an underwriter must look for, prior to issuing a full loan approval or loan commitment.
This is only the beginning and it is a cake-walk. I would like to take this a step further to show you how fast a loan application can get very complex and frustrating for some borrowers.
Let’s take a fictitious couple and we will call them Jack and Jill Applehead. The Appleheads both have credit scores in the high 700’s. Both have been at their respective careers for over ten years. Jack works for a kitchen cabinet company inside the shop and works forty hours a week with some overtime.
Jack’s company has been getting very busy over the past six months and his boss has asked him if he would like to help out on the weekends installing cabinets but get paid by the piece.
Jill owns her own hairstyling shop and has done well for years. She pays herself a small modest pay check every week of $400 and also gets some nice cash tips, but only claims about 20% of them on her paycheck. Together, the Appleheads do very well and having been saving money and paid off most of their credit card debt this past year and are now ready to buy a home.
Now we have to figure out the Appleheads qualifying income. Let’s start with Jack. His income will break down as follows. First his forty hours a week standard pay is good and verifiable. His overtime pay will have to be verified by a VOE and averaged out over the past 24 months. His weekend piece work will not be qualifying income as he only has a 6-month past history. For this income to count Jack would have to have a two-year history receiving this piece work income and a VOE from his employer stating the likely hood of it continuing. However, this weekend piece can count towards the Applehead’s down payment and closing cost.
As for Jill, her income starts with her modest pay check, which is verifiable and will count. The tips she claims and shows on her pay stub will count too but will be averaged out over the past two years, using her tax returns as verification. Since she is self-employed, the profit of the business needs to be factored in as well.
Hopefully her business shows a profit, as a lost will have to be subtracted from her qualifying income. If she has shown a profit, that profit will be averaged together over the past two years to factor in her monthly income. However, if the most current year she has made less than 10% from the prior year, she maybe showing declining income—unless she increased her weekly pay check. Declining income could be cause for a loan denial.
Another note about Jill’s income, the cash tips that she does not claim on her paystub or tax returns cannot be used for any part of their home purchase whatsoever.
As you can see, when a person just states their income over the phone to a loan originator, in order to get a prequalification letter, the prequalification letter will only be as good as the perceived facts that have been verified. Income can get very complex when dealing with self-employed people. The situation is even more complex when both borrowers on a loan application are self-employed, own multiple businesses, and own multiple properties.
I see many self-employed individuals move money around from company to company. They take income in different methods each and every year, either by capital gains, distributions, standard pay checks and other means including paying off person debts such as credit cards through the business. These methods of receiving income may seem simple but without consistency, it is very hard for an underwriter to prove that there has been a good past history as well as the potential for continuous steady income for the next three years.
Working with a good CPA to save money on taxes is great, however a good CPA should also help you plan and structure your business for you to have steady income in your business and your personal life. Ask questions, get your facts, and we will see you at a happy closing table.