Get Your Income Ready to Buy a Home
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Many people buying a home assume the biggest reason that they might be turned down for a mortgage application is bad credit. While credit history is very important and is a common reason lenders deny mortgages, they just as often reject an applicant who has insufficient income.
Why income is so important when you’re applying for a mortgage
Your credit history is a good indicator of how you’ve paid the credit you owe in the past, but your income is of equal importance in your ability to repay a new loan. Studies have shown that borrowing 43% or less of your total gross income to buy a house makes it less likely you’ll run into problems making your payments down the road. In fact, 43% is the top end of what’s generally considered an acceptable back-end debt-to-income ratio, or the share of your gross monthly income that must go toward your new mortgage payment and other monthly debt payments.
Besides the debt-to-income ratio, the lender wants to look at how you earn your money, how long you’ve been getting it and how long you’ve been in your field of work. There are a number of other things we’ll cover below to ensure you are ready to get a mortgage based on your income.
Signs your income is solid enough for a mortgage loan
Lenders are mostly concerned that you have a history of stable income, and that your income will remain consistent into the future. The items below are signs your income is solid enough to get a mortgage.
- You have 2 years of consistent employment earnings: Lenders mostly focus on your most recent two years of income, plus what you’ve made so far this year. If your income has stayed the same, or increased a little bit every year with bonuses and raises, you are considered to have stable income.
- You receive a salary or guaranteed hourly wages: Another sign of good qualifying income is if you receive a set amount every year as a salary, or have an hourly rate that is guaranteed for at least 40 hours per week.
- You have 2 years on the job: If you’ve had the same job for the last two years, or no more than three employers in the last two years with no periods in between jobs where you weren’t employed, then you are considered to have good job history stability.
- You have 2 years in your field of work: Lenders want to know that you’ve been in your field of work for at least two years.
- You have 2 years in your current position: In general, it’s best if you’ve been in your current position at least two years.
Signs your income may not be stable enough for a mortgage loan
- You have a new job or have had multiple jobs in last 2 years: If you just started a job or have had more than three jobs in the last two years, lenders will be concerned about your earnings stability. Lenders don’t like to see a lot of different employers on your application in the past 24 months because very often those job changes come with gaps in employment, making your income less predictable.
- You’ve been receiving overtime less than 2 years: If you just started a new job as a nurse or police officer, you may get a lot of overtime income. Unfortunately, the current guidelines require a history of receiving that income for the last two years for a lender to consider it.
- You’ve been getting commissions or bonuses less than 2 years: If you just started a commission job, even if you’re doing great your first year and getting large commissions and bonuses, lenders will want to see a two-year history of these earnings to determine if the income is likely to be stable.
- You write off unreimbursed business expenses on your tax returns: A lot of commissioned employees will write off expenses on their tax returns. While this is a great way to reduce your taxable income, the amount of expenses that shows up on your tax returns may be counted against you as a monthly debt.
- You’ve been in your current field of work less than 2 years: If you recently changed fields of work, or re-entered the workforce after a period of six months or more, it will be more challenging to get a mortgage.
- You graduated from college or trade school in the last 2 years: If you just started working after going to school, you may not qualify unless you are working at a job directly related to your college or trade school education.
- You switched from salaried or hourly earnings to self-employed/commission: You may be earning a lot more from your new sales position at your employer, but if your income switched from a guaranteed hourly rate or salary to a commission, you’ll need a year or two of history before your new income can be used to qualify.
- You are self-employed: Lenders look at your income differently when you are self-employed. When you are salaried, your gross income (pretax earnings) is used to qualify, but when you are self-employed, lenders look at your net income, which is how much you get after all your business expenses are deducted from your gross income.
What you can do to strengthen your income
Even if your income has some or several signs of instability, you can still do things to make a case for your income. Underwriters are willing to look at letters of explanation and documentation to make exceptions, and a final determination of whether your income is stable enough for mortgage approval.
- Get letters from your employer guaranteeing or explaining your working hours: If you are new on the job, many employers are willing to write a letter or fill out a verification of employment form confirming you are guaranteed full-time hours (usually 40 hours per week).
- Get a letter from your employer regarding switch from salary to commission: If you established a customer base while you were a salaried or hourly employee, lenders might consider your new commission income, if your employer verifies you are doing the same type of work but simply are paid now as a commissioned employee.
- Get a letter from your tax professional for self-employed income increases or decreases: If you are self-employed, your accountant will provide you with strategies to maximize your income and minimize your tax liability. These strategies may make it look like your income dropped — or increased substantially. If your tax professional explains that the lower income was due to something that won’t happen again — like a large expense for updating equipment — the lender may be able to add back the expense for that tax year and give you more qualifying income.
- Provide a letter and documentation regarding education leading to new field or position: If you are a recent college or trade school graduate, provide a copy of your degree and transcripts from school to show how you’ve been planning for your new career or job position. In most cases, this will be enough to waive the condition for verifying two years of work history in your field.
- See if someone will cosign on the loan with you: If you find that you don’t have enough income to qualify, you may need to consider asking someone to cosign your loan. This should always be a last resort since it makes the cosigner responsible for your loan if for any reason you aren’t able to make the payments.
- Try a bank statement only qualifying program: If you are self-employed and have found a house you really like, some programs will allow you to provide 12 to 24 months of personal or business bank statements instead of tax returns to qualify. If you’ve got at least 5-10% for a down payment and are OK with a significantly higher rate, this may be a good short-term option, until your tax returns show more income in the future.
Income no-nos during the mortgage process
There are some very specific income-related moves you don’t want to make once the loan process has started — they could lead to loan denial.
- Don’t change jobs or fields of work: Even if you are taking a much higher-paying job, it’s best not to change jobs or fields of work until your loan is complete. If you know a big change is coming up before you start house hunting, it’s best to wait until your new job has started before you fill out your loan application.
- No switches from full-time to part-time: Be sure not to switch from a full-time position to a part-time one. Lenders will reverify your employment and position right before closing, and many will even verify it again on the day of closing.
- No switches from salaried/hourly to self-employed/commission: Even if there is a large bonus payout or commission, a major change like this is likely to cause a major problem for you to qualify, especially if your loan is already in process.
What you’ll need to verify your income
- Copies of a current month’s worth of pay stubs: You’ll need to provide your most current month’s worth of pay stubs. That means if you’re paid weekly, you’ll need four pay stubs; if you’re paid biweekly, two pay stubs, etc.
- Copy of last 2 years’ worth of W-2s: Be sure you provide copies of all W-2s for all jobs worked over the last two-year period if you have more than one job.
- Provide names, phone number and human resources contacts for your employer: You’ll need this information for the last two years to fill out your loan application, and may also need it if the lender needs to contact your employer directly to answer any questions about your income.
- Start dates and end dates last 2 years of employment: This may seem obvious, but any errors in this section can create problems later, especially if you had some gaps from one job to another.
- Your most current 2 years of full tax returns, personal and business if you are self-employed: You’ll just need the federal schedules, but you’ll also need all the pages of the returns. If you have business tax returns, such as partnership or corporation returns, you’d need to provide the most current two years’ worth of returns.
- Prepare a basic profit and loss and balance sheet for this year if you’re self-employed: Since you don’t get a pay stub if you’re self-employed, lenders will want to see how things are going this year. This doesn’t have to be prepared by a tax professional —a simple breakdown from an accounting program should be fine.
- New hire letters if you just started a job: If you’re new on the job and don’t have a pay stub yet, provide a copy of your new hire letter, with all of the information showing your income, how you will be paid and your start date.
- Provide your college degree, trade school certificate and school transcripts: If you just graduated from college or completed a trade school certification, provide a copy of the degree or certification, and copies of the transcripts for all the classes you took.
The bottom line
As you can see, lenders look at much more than just how much you make every month when they are considering approving you for a loan. If you keep the information above as a reference guide, you’ll have a pretty good idea of whether your income and employment history are where they need to be for you have a good chance at getting a loan approval.
If you have all of the income documentation at your fingertips when you get ready to apply for the loan, you’ll be able to fill out the application much faster. You’ll also have most of what your loan officer is likely to ask for, which will make your loan process much smoother.