How Much Do You Make? A Lender’s View of Your Income
By Doug Goelz, Mortgage Services
One of the first questions I ask a client when someone is applying for a mortgage is, “How much do you make?” It’s a seemingly simple question, but the answer, for a mortgage lender, is almost always complex. In general, lenders tend to adjust income to make it conservative (e.g., by averaging a history of income, or reducing income by various expenses), but they also give credit for non-cash expenses (such as depreciation or expenses for use of a home office) that may reduce taxable income.
Here are a few simple rules about what a lender does not count as income, plus a few rules on adjustments that increase“qualifying income” (the income a lender uses in deciding how large a loan a borrower can afford).
A lender generally does NOT count the following as qualifying income despite the fact that all the payments below have real monetary value and can be taxable:
- Cash bonuses if you have not been paid bonusesthe past two years by your current employer.
- Non-cash bonuses such as options and RSUs.
- Self-employment income unless you have filed a Schedule C or E with your last 2 yearsof tax returns.
- REVENUE, before expenses. Some people who are self-employed or own their own business are confused by this notion: lenders don’t count how much clients pay you as income; they count your revenue AFTER expenses as qualifying income.
- Cash payments not reported on income taxes.
- Roommate income. Unless the property in which you live is a multiple family dwelling (e.g., a duplex), rent you are paid by people who live in the property (such as roommates, children, parents or even partners) does not count as qualifying income.
- Dividend or interest income from assets that will go away when you buy a property. Let’s say you earn dividends on stock you own, but you are going to sell your stock for the down payment for your new home. Even though you have a history of dividends, the lender can see that the stock generating the income is going away, so they won’t count the dividends as qualifying income.
- Capital gains, unless you have a history of capital gains AND still will have the assets on which you have generated capital gains after you buy a house. If you routinely buy and sell stock and have capital gains, and you will maintain your portfolio of stocks after you buy a house, the lender may count your average capital gains as income.
- One time payments. For example, lenders don’t count sign-on bonuses, lottery winnings, or civil suit settlements as qualifying income.
Lenders also INCREASE qualifying income by recognizing that not all expenses on tax returns are cash expenses, and that not all income is taxed. The following can lead to an increase in qualifying income:
- Depreciation expense. In general, lenders add back depreciation that is shown on a tax return as long as the borrower still owns the depreciated asset. So, even though a rental property may show a loss for tax purposes, the lender may view it as an income generator after adding back the depreciation expense.
- Expenses for use of home offices.
- Non-taxable income (such as some social security income and tax-free interest income) is grossed up by 25%.
When you talk to a lender to get pre-approved for financing, be prepared for a barrage of questions about how you earn your income. In complex cases, a lender may have to see your tax returns and other documentation before being able to figure out the loan amount for which you will qualify.
Questions? Feel free to get in touch with me at 415-730-4665 or doug@emortgageservices