Pandemic Complicating How Much Mortgage Based On Income Decision

Mortgage lenders look at a variety of factors when determining how much their customers can borrow. Income plays a big role in that process, and income can mean a lot of things in this pandemic that is upending the financial lives of millions of Americans.

The longstanding advice among experts (and even some lenders) is to keep mortgage payments within 28 percent of your pre-tax earnings. This helps ensure that you’re not stretching your budget to the limit, which could result in trouble paying your mortgage down the road if unexpected financial difficulties crop up.

If you look at the scenario below, a borrower who earns $6,000 per month, factoring in debt, down payment, and other costs, would be able to afford a monthly mortgage payment of about $643.

How much home can I afford?
Gross monthly income: $6,000
Down payment: $20,000
Loan term: 30 years
Annual real estate taxes: $3,000
Annual home insurance taxes: $2,000
Mortgage interest rate: 3.5%
Car payment: $350
Credit card payments: $600
Student loans: $150
Total monthly expenses (including home insurance and property taxes): $1,516.67

An easy way to figure out how much you can afford is to use Bankrate’s mortgage affordability calculator. This is a helpful tool for crunching the numbers on your debt, income and down payment to get a rough estimate of an affordable home loan. If you have a partner who will also be on the loan, add their debt and income into the equation, too.

Lenders also balance your income with your recurring debt, this is called the debt-to-income ratio, or DTI. Recurring debt is usually paid monthly on a long-term basis, such as car payments, credit card debt and student loans.

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Fannie Mae and Freddie Mac have maximum DTI requirements of 45 percent. FHA loans max out at 43 percent and the monthly housing costs (including taxes and insurance) can’t go above 31 percent of gross monthly income.

You can figure out your DTI by dividing total recurring monthly debt by monthly gross income. If your gross monthly income is $3,000 and your debt is $1,200 per month ($1200 ➗$3,000 = .40), then your DTI is 40 percent.

What qualifies as income

A wide variety of monetary sources counts as income, not just your paycheck or dividends income. Lenders will consider alimony, child support, disability insurance and tips that you earn on the job, among other things.

The constant among all of the sources is that they must be documented and show a history of consistency. A one-time cash gift won’t be considered income (unless you can live off of that gift).

“The key is if you report it you can use it. Whether it’s gig economy or the service industry, they might make a lot of cash money, but they report what they report. So if you under-report your tips, for example, that’s great for keeping your tax base lower, but it will be tough to get a loan if you can’t prove what you earn,” says John Pataky, chief consumer and commercial banking executive at TIAA Bank.

Lenders will look at two to three years of income, so it’s important to show consistency. If one year you earned $150,000 and the next year you earned $70,000, you might qualify for a smaller loan amount.

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However, if you get a raise or promotion and it’s clear (by employer verification, for example) that this is how much you’ll earn going forward, then the lender will usually consider your new income as what you make, even though it’s not the same as the previous years.

Furloughs, Airbnb and closed businesses don’t count

Since your income is one of the main ways lenders can gauge your ability to repay a mortgage, reliable income is essential. That means workers who are furloughed would not qualify for a mortgage if their paycheck is their only source of income.

Conversely, borrowers on temporary leave may still qualify for a mortgage as long as their return to employment is verified. Maternity leave, short-term medical disability and other temporary leave types “acceptable by law,” according to Fannie Mae, fall under this category.

Borrowers collecting unemployment insurance will typically not qualify for a home loan. Lenders won’t allow unemployment insurance as an income source on an application, unless the borrower is a seasonal worker, such as a construction worker, contractor or someone who works in the entertainment industry.

Airbnb income is also a no-go as it’s tough to prove consistent income from vacation rentals. The same is not true for people who rent a room in their home or have rental property income, as tenants sign leases which can prove a steady, consistent stream of earnings.

Business owners who closed their business can’t use past earnings to prove income as that well is now dry.

What homebuyers should know

If you’re preparing to buy a house, write down all of your streams of income. Talk to your lender about what counts and how you can use your funds to secure a mortgage that works for you.

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If you’re self-employed, lenders typically require a minimum of two years’ worth of federally filed taxes.

If you’re ready (or almost ready) to buy a home, start researching lenders that meet your needs. Word-of-mouth recommendations are a great place to start. Once you find a lender, they can help you through the process, including assessing what loan amount and interest rate you might qualify for based on what you earn, what you owe and what you have in the bank.

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