The trend now is to do online research prior to doing anything...whether it is buying a car, an expensive appliance, or even obtaining a mortgage loan. What usually happens is a potential buyer drives by a home that strikes them as a property that may meet their needs. They look the home up on the Realtor's website, get the price and the particulars of the home. Then they search for a mortgage loan calculator and figure up the payment. If they haven't spoken to a lender yet, the payment may or may not be realistic as interest rates are subject to credit scores, loan amount, and type of loan. However, our intrepid buyer may not know all that yet, and sees that the payment is only $20 higher than what he has been paying for rent and believes he can afford the house. He may be right, then again, maybe not. There are many times when calculating income for a borrower may be just as vague as calculating the value of that golden egg. There are so many factors that come into play, the price of gold not withstanding.
Let's take a look at how lenders calculate income. This should give you a bit more understanding of how much mortgage may be in your future.
Generally speaking you do have to be employed full time in order to obtain a mortgage. Full time hours vary but 35 hours plus per week constitute full time employment. The easiest calculation to make is for those who are salaried-or have a guaranteed income no matter how many hours they work. So if you are salaried at $60,000 per year, your income for mortgage purposes is $5000 per month. Mortgage calculations use gross pay, or pre-tax pay, not the net amount that is your paycheck. Hourly rates are easily calculated as well. Normally there is a number of hours per week that the employee is expected to work. That is base pay. The number of hours is multiplied by the hourly wage. Sometimes folks just figure they work 40 hours per week when they work 36. While it may seem that the difference in income between 40 hours and thirty six hours isn't much-over the course of a year it adds up to several thousand dollars which in turn affects how much an individual can spend on a house so accuracy is important.
Overtime, bonus and commission calculations have additional rules. In order to use any of the aforementioned types of income for mortgage purposes the employee must have received them for the past two years with the same company. This is critical. Often people assume they can use the overtime whether or not they have a two year history or not. In fact, interruptions of employment can be an issue. Let's take the example of an employee who had worked for the same firm for seven years and receive overtime pay. Five and one half years into his employment he resigned and took another job. Two weeks into the new job he realized he had made a mistake and returned to his old company. A year and a half later when he made loan application, the brief interruption in service was nothing more than a faded memory. He applied stating he had been with his current employer 7 years. However, when the verification of employment came back, the interruption in service had been noted by the employer. The lender refused to let his overtime be used in mortgage qualification. His ability to afford the house he was buying was reduced. So you can see by this example, two years of overtime, means two continuous years of overtime.
Another interesting quirk of lending is that if you have declining income in the present year, that is the income that will be used. In other words, averaging is fine as long as your income is growing, but let it decrease and averaging goes out the window. Good to know.
It is usual that someone who works part time inquires about a mortgage loan. Most people understand that a part time situation doesn't normally earn enough for mortgage qualification. But there are exceptions. One might be a retired person who works part time in addition to receiving retirement income, or the spouse of a borrower with full time income. The rule on part time situations is that the position must be held for two years in order to count the income. This is true in most cases if someone moves from full time to part time within the same company. So don't count on your part time job being allowable income when you are figuring what you can afford.
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Self employed borrowers are another category of income that gets special treatment. The biggest issue with self employed borrowers is that the benefit that their accountants create for them on their tax returns becomes a huge liability when it comes to mortgages. The job of accountants is to minimize tax liability but in doing so, if your accountant has not asked you the question, "Are you planning on purchasing or refinancing a home in the next two years?" he may be doing you a huge disservice. When looking at the income of self employed people, lenders want to know one thing:
How much is your net income. Not how much revenue did your business take in, but how much net income after all the bills are paid did you receive. If you are showing net income of $3000 on your taxes, chances are you won't be approved for a mortgage no matter how much your sales numbers were. For self employed folks, that net income has to be enough when averaged over two years to afford not only your house payment, but all your other consumer debt. So if you have been expensing away your profit, you will want a two year plan if you intend to purchase a home in the next few years. You have to decide, pay lower taxes or buy or refinance a house. You cannot do both at the same time.
I am going to stop right here and toss in a bit of free advice: if you are self employed keep your business and personal accounts separate. If you drive a truck that is for your business make the payments out of the business account. Have a separate credit card for your business. Keep a big bold black line between the personal and the business. It is so much more difficult getting a mortgage loan approved when the business expenses have to be weeded out of the personal expenses. If they are separate we don't have to lump it all into your debt ratio.
The last bit of information for today is for anyone who files a long form tax return-whether self employed or not. If take losses or reoccurring expenses on your tax return, they will be deducted from your income. If your spouse is the one who is obtaining the mortgage, if you file taxes jointly and show a loss, the deduction will come off of your spouse's income. In other words, less buying power. Keep that in mind and discuss these situations with your accountant.
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