Most mortgage program guidelines follow the “rule of twos.” So what do you do when you have income gaps? Loan approvals require a lender to verify at least two years of employment. For self-employed borrowers, two years of self-employment is required and verified with at least the last two year of federal income tax returns. As it relates to income, there needs to be two years of income and employment which is verified by viewing the last two years of W2 forms. Lenders will also need copies of the most recent paycheck stubs. On these stubs, there should be a gross amount shown, a net amount and a year-to-date total. If someone makes $5,000 per month and it’s the end of October, the paycheck stub should show something around 10 times $5,000, or $50,000. In this scenario if the year-to-date totals show $30,000, then something’s not quite adding up and the lender will spot the anomaly.
Maybe someone got a big raise during that period of time. That makes sense. But program guidelines will want to see some verification of that big raise from the employer. If there is a reduction in income due to an income gap, there needs to be more information provided. An income gap is a period where income was not received. If the borrower gets laid off for a month or two before going back to work, the guidelines need some assurance the time off was an isolated incident. Otherwise, there may not be enough income one month to meet all the bills. Guidelines require a reasonable determination that all qualifying income will continue into the future. Verifying two years of consistent income in the past typically meets this guideline.
Family Leave is another sensible reason for taking some time off. Family leave guidelines can vary from state to state and loan program to loan program. An extended illness can also be an acceptable instance for an income gap. For someone that was laid off but found a new, similar job, an income gap is acceptable. In essence, the reduction in income needs to be documented as temporary and the current income will continue well into the future.
Explaining an Income Gap
For many income gap explanations, it’s simply a matter of writing a letter, signing and dating it and explaining the reason for the temporary reduction in income. If a loan underwriter has some questions about the gap in income, there’s no reason for alarm if the reduction can be reasonably explained. If you’re not sure how to put the letter together, I can help you write a letter that will be acceptable to lending guidelines. Some loan programs aren’t that concerned with an income gap as long as you’re gainfully employed. It’s best for you and I to speak about your situation so we can address this upfront and not have to tackle it during the actual loan approval process.
As part of the initial documentation process, our loan processor and me personally will review the information provided to make sure your loan file is complete and ready for an approval. It’s at this stage we will make the determination that an income gap explanation letter will be needed as part of the completed loan file. This will speed the approval process. It’s better to address any potential issues head-on rather than waiting.