One of the determinations lenders must make when evaluating a loan application is whether or not the borrowers can comfortably afford the new mortgage payments. Regular income, revolving debt, installment debt, and outside income are all considered. This is done primarily by way of debt-to-income ratios, or simply “debt ratios.” Most loan programs provide guidance on these ratios both in terms of the new total house payment, including taxes, insurance and mortgage insurance (when needed) as well as a total debt ratio. The total debt ratio includes the housing ratio plus all other monthly credit obligations. In general, the housing ratio should be around 33% while the total debt ratio can be somewhere are 43%. Some programs allow for ratios higher than that but they are less common.
This comes into play when first getting a preapproval. A preapproval lets the borrowers know their file has already been reviewed and the only thing left to provide is a property address. The preapproval can be up to a certain amount or it can be for a specific property. When calculating debt ratios, monthly debt is compared with gross monthly income. What is considered income in a lender’s eyes, and what is outside income?
There are guidelines that determine what type of income can be used to help qualify. The most common is a regular paycheck. Lenders will want to see evidence of regular monthly income. One way to document this is to review the most recent paycheck stubs over a 30 day period. Lenders also want to see a history of employment of at least two years. This is verified with two years of W2 forms or the last two years of personal and business tax returns if self-employed. But there are other types of outside income beyond a regular job and being self-employed.
Part-time income comes to mind. Can part-time income be used to help qualify? Yes, but the income needs to be shown as both regular and consistent along with a proven history. For part-time work, lenders will need to verify a two-year history of receiving such income along with documentation showing a monthly amount. Someone who works seasonal jobs such as a lifeguard in the summer or someone who works at the mall during the holidays is considered seasonal. Will the lifeguard continue being paid in December when the pools are closed? What about shopping mall traffic in the middle of summer? Either can be used by showing the part-time income has a two-year history and will be receiving it again in the future or verify the part-time income is being currently received.
Other Types of Outside Income
Bonus income also can fall into the outside income category yet is most commonly associated with being employed or self-employed. Does the employer have a universal bonus income calculation used for all employees doing similar work? Is there a quarterly performance bonus or a one-time bonus only paid at the discretion of someone’s boss? If bonus income can be shown to have a two year history and is consistent over that period, it can be used. If the bonus is paid but there is no evidence of it being paid in the past, a lender will carefully scrutinize the income to determine whether or not the income will continue into the future.
How about a co-borrower? How about someone’s parent or relative’s income to help? Most loan programs allow for a non-occupying co-borrower to help qualify by bringing additional income to the equation. However, if non-occupying income is used, the non-occupant’s current debt and credit scores will also be evaluated. Sometimes this additional debt doesn’t contribute to qualifying, bringing the total debt ratio- the debt ratios of all borrowers on the application- beyond allowable guidelines.
The bottom line for all outside income is essentially the same across the board. There needs to be a verifiable history of receiving it, it must be consistent and the lender must determine whether or not the income is likely to continue into the future. If you have some income that you’re not sure if it can be used to help qualify, just give me a call and we can work it through together.