How Is Income Calculated for a Mortgage?

When trying to purchase your first home, many things can be confusing to borrowers during the mortgage process. From acronyms like DTI, ATR and front-end and back-end ratios, calculating income is an area many first time homebuyers don’t understand.

However, a simple review of how lenders will evaluate your income can help you determine if you are buying a property that fits within your budget.

Debt-To-Income Ratio

A major factor in determining if you can afford a home or not is your debt-to-income ratio. There are two types of DTI ratios – front-end and back-end.

A front-end ratio is calculated by taking the full mortgage payment and dividing it by your gross monthly income. For example, if a borrower’s mortgage payment including principal, interest, taxes and insurance is $1,500 and their monthly income is $6,000, the front-end ratio is 25%.

The back-end ratio is calculated the same way with all other borrower liabilities included (debts for auto and installment loans, credit cards, child support, alimony, etc.). Using the example above, say you have total other liabilities sum of $500, then your back-end ratio would be 33%. The DTI ratio with these front and back-end figures is 25% / 33%.

Note: To determine front-end ratio and back-end ratio for your particular income situation, try our Debt-To-Income Ratio Calculator.

Each loan program has their own debt to income ratio tolerance.

  • For conventional loans, the debt-to-income ratio is usually 28% / 43%.
  • FHA loans have a back-end ratio of 50%.
  • VA loans can have DTIs that go as high as 57% with many lenders.
  • The maximum DTI for a USDA loan is 34% / 46%.

Types of Acceptable Income

Lenders will accept varying types of income and guidelines are different depending on the type of income used to qualify.

Full-time Employee: Lenders will want to see a borrowers W2 for the last two years to evaluate income for full-time employees. They will usually request 30-days’ worth of paystubs as well. If a borrower has an offer contract for a new job, lenders will typically accept this for income.

Self-Employed: Self-employed borrowers find it hard to qualify as many of them take advantage of writing things off on their taxes. This hinders their ability to obtain a mortgage as lenders will use the reduced taxable income to qualify the borrower. To evaluate self-employment income, lenders will request personal and business tax returns for the last two years. They will want to see all schedules associated with the business tax returns. Each lender has separate requirements for self-employed documentation. Many borrowers will turn to non-QM lenders for bank statement loans.

Governmental Income: Homebuyers whose income is derived from social security, disability or military payments can use it to qualify for a mortgage. Lenders will want to see an SSA-1099 or 1099-R depending on the type of income received. Depending on the loan program, this income can be grossed up between 15% to 20% since it is non-taxable.

Alimony & Child Support: Court ordered income such as alimony and child support can be used to qualify if the income is likely to continue. Lenders will typically want to see a 3-year continuance on the income to use it for qualification.

Retirement Income: Income received from retirement accounts can be used to qualify for a mortgage if it will continue for up to 3-years. Lenders will typically only evaluate 70% of the account balance due to market volatility.

Rental Income: Income from investment properties can be used to qualify. Lenders will require a lease that’s in place and will use 75% of the monthly lease income. That figure will be net of any current mortgage payment on the property, taxes, insurance and HOA dues.

Final Word

Lenders will accept various amount of income types and these types can even be combined to improve your chances of qualifying for a mortgage. Before buying a home, it is recommended that you consult with a financial planner or loan officer to determine how much home you can afford and what programs best suit your homebuying needs.

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