Lenders want to make sure you can afford the new monthly payments that come with a new mortgage. Makes sense, right? Well, not only does it make sense but so-called ‘Ability to Repay’ or ATR determinations are the requirement of most every residential mortgage made in today’s environment. Lenders make that determination by comparing gross monthly income with the new mortgage payment, which includes taxes, insurance and private mortgage insurance when required. The key word here is ‘monthly.’
Lenders reviewing someone who gets paid on the 1st of each month have it pretty easy. There’s one paycheck issued each month, hence the ‘monthly’ requirement is satisfied. So too are those who get paid on the 1st and 15th. The lender will ask for copies of recent paycheck stubs to third-party verify gross monthly income. The paycheck stub will clearly show the amount of gross monthly income along with year-to-date totals. The paycheck stub will also show various deductions, but those deductions have little to do with calculating qualifying income. It’s income that’s the concern, not deductions.
Bonus income may also be used but it too must follow certain rules. Bonus income must have at least a two-year history of being both consistent and disbursed. There’s a little twist here though. If there is only one bonus issued, such as an annual merit bonus, it won’t be used to help calculate qualifying income. Why not? Because a bonus issued in December probably won’t be around next August. It’s been spent. Quarterly bonuses can work as long as there’s the history of receiving it, but a one-time payment or occasional bonus probably can’t be used.
For the self-employed borrower, it’s a bit more involved. Someone that is self-employed can withdraw funds on a particular day or days of the month. This consistency is important to a lender. If someone has been withdrawing a specific amount of funds from the business to be used as income, it’s relatively plain what amounts are used in order to qualify. Most self-employed borrowers don’t set up this arrangement but get paid when a client pays an invoice for products or services provided. In this instance, lenders want to see the previous two years of tax returns and a year-to-date P&L. With this information, those total payments are then averaged over that period. The result is the amount lenders will use to determine affordability.
But there’s another kink for those who receive a paycheck from their employer. What happens when someone gets paid every other week? Getting paid every other Friday for example isn’t the same as getting paid on the 1st and 15th. In this instance, a little more math is needed. Not much more but a couple of additional steps, anyway.
Qualifying income for someone getting paid every other week means 26 paychecks. Since there are 52 weeks in the year and getting paid every other week means 26, right? The paychecks are then reviewed and the total gross income appearing is added up. Then, the total is divided by 12 (months). If each paycheck stubs show gross disbursement of say $3,000, the lender multiplies that amount by 26 (weeks) to arrive at a figure of $78,000. Finally, that amount is divided by 12. The result is $6,500 per month.
Your loan officer will help you calculate qualifying income if you get paid every other week, it’s really not hard. But for those trying to calculate their income on their own and they use $6,000 for qualifying income (two checks per month) they’ll be short-changing themselves.