Despite the fact that it may be the largest financial transaction you will ever make, advancements in technology have made it easier than ever to pre-qualify and then to officially apply for a mortgage loan. When applying for a home loan, specific documentation such as income verification is required. Don’t worry, we’re going to break down this piece of the process and dispel the myth that providing various types of income documentation is complicated.
Because a mortgage is a significant amount of money loaned, lenders want to make sure you can make those monthly payments and ultimately repay the loan, without the risk of missing payments, default or significant financial burden on the borrower. Income verification is a basic component of this, and your lender will want the paperwork to back it up. While different lenders may require different documentation, as do different loan products (think FHA and VA streamlines if you’re looking for fewer docs), you can consider the following as verifiable sources of income that will need official documents:
- Employment income
- Bonus, overtime and commission income
- Second job or side hustle income
- Retirement or Social Security income
- Investment property and rental income
- Dividend and interest income
- Child Support, Alimony/Spousal Support, or Separate Maintenance Income
- Foreign income
- Self-employment income
Understanding the Verifiable Sources of Income When Getting a Mortgage
Some borrowers believe that you only need to provide your most recent paystub to show proof of income. Actually, it’s almost that simple; most lenders require copies of the last two pay stubs, as well as your last two years of W-2 statements. Together, these official documents provide a clear picture of your overall financial situation and the consistency of your regular earnings.
We’re living in the 2020’s, so paper is out. You can provide electronic copies of your pay stubs, and you can authorize your lender to obtain your federal tax returns directly from the IRS, which makes it easier on you. Programs such as the IRS’ Income Verification Express Services allow lenders to confirm the income of a borrower during the application process. Though lenders are looking for financial stability, this doesn’t mean there’s necessarily an issue if you have recently changed jobs or even industries in the past two years. In these cases, the lender may ask your new employer for a proof of income letter.
Bonus, overtime and commission income
In order for annual bonuses, overtime or commission income to be considered, you must have an established history of receiving that type of compensation and evidence it will likely continue. Here again, copies of W-2 statements for the previous two years and two recent pay stubs can work to verify this type of income. If a substantial part of your income is commission-based earnings, your lender may need to obtain copies of recent tax returns to verify the earnings. They’ll then likely average the amounts you have received over the past two years to calculate the amount that can be considered a regular part of your current and future income.
Second Job Income
If you’re a go-getter with a second job or side hustle, you may use this income to qualify if a consistent two-year history of secondary employment can be verified. Lenders are looking to verify you have a two year history of being able to work both a primary and a secondary job at the same time to show that you are likely to continue to do the same in the future.
Retirement or Social Security Income
If your pension or retirement income is deposited directly into your bank account, expect your lender to ask for copies of your recent pension check stubs or bank statements. Sometimes it is necessary to verify that this income will continue for at least three years into the future, since some pension or retirement plans do not provide income for life. This can usually be verified with a copy of your award letter. If you don’t have the letter, we recommend that you ask your lender if they can contact the source of this income directly for verification. If your distributions from retirement assets are not distributed on a monthly basis, which is typical, the income is still eligible with a documented history of 1099-R statements or tax returns.
Rental Income from an investment property
If you want to use rental income to qualify, you’ll just need the proper documentation and the ability to show that the income from your rental properties will continue. Expect to provide most recent year’s federal tax return to verify your rental (schedule E, which shows supplemental income and loss, is key here), as well as a one- to two-year history of rental income.
Dividend and Interest Income
There’s a common theme emerging: Have two years of personal tax returns ready so your lender can verify the amount of your dividend and/or interest income to calculate an average amount. In addition, they’ll want to verify ownership of the assets that generate the income, using current copies of statements from your financial institution, brokerage statements, stock certificates or promissory notes. Keep in mind that, typically, income from dividends and/or interest must be expected to continue for at least three years to be considered.
Child Support, Alimony/Spousal Support, or Separate Maintenance Income/
To use this type of income during a mortgage application process, you’ll want to have a court order or divorce decree ready so your lender can verify it and its continuance into the future. They’ll want to document consistent receipt for at least the most recent six months.
Foreign income may be considered to qualify, depending on how that income is paid and documented on your personal tax returns. If considered, foreign income requites two years of tax returns, as well as standard documentation based on the type of income. As an example, employed income would require a current paystub.
Things may get more complicated for self-employed business owners and entrepreneurs, but not to worry. You’ll need to provide those federal tax returns again (for the most recent two years), both personal and business, if applicable. Expect your lender to focus in on schedule C, which reports on income and loss from your business, and to look at both expenses and deductions.
In certain circumstances, it may be necessary to provide additional documentation, such as copies of a year-to-date profit and loss statement and business bank statements. In all cases, current verification that your business is open and operating is required.
What is a debt-to-income ratio (DTI) and how does it play in?
This leads us to a favorite topic: DTI. While income is a tremendously important factor in qualifying for a mortgage, your lender is also going to look at your outstanding debts which is key in calculating your DTI. It’s important to note that different loan options and lenders may have different DTI requirements.
What you need to know is that DTI is a percentage of your monthly gross income that goes toward paying your debts, and the ratio can cover more than just the outstanding debts listed on your credit report. DTI is calculated by dividing your total, monthly recurring debt by your monthly gross income. A lower DTI is preferable when applying for a loan, and the general guideline is that lenders typically want to see a DTI of less than 36% with no more than 28% of that ratio going toward your mortgage. Keep in mind, though, that the maximum DTI allowed will vary by lender and loan type. If you have a high debt-to-income ratio, check out these tips to reduce your DTI.
The benefit of a mortgage income calculator
You’ve now got a good sense of your income options and what you can afford. Still, it never hurts to advantage of a Mortgage Income Calculator, which can help you run the numbers based on your specific sources of income. At AmeriSave we have a Home Affordability Calculator that lets you estimate what you can afford based on your current monthly income and monthly debt payments.
Ultimately, you can set yourself up for success by gathering and organizing the types of income documentation we’ve outlined above. Then, talk to a professional loan originator to ensure you fully understand how your income matches up to their mortgage lender requirements. This way, what you may have originally thought was an arduous process may actually be a breeze.