Lenders evaluate a loan application submitted by someone who gets paid by commission gets treated a bit differently during the underwriting process. As one might expect, a commission check will likely vary each pay period. Commissions are paid based upon the amount of total sales for that period. Commission amounts vary but due to the nature of the paycheck calculation, employees and employers come to an agreement on the amount of the commission per each paycheck and how often it is paid. If someone gets a 50% commission which is paid at the end of the month and the total sales eligible for commission is $10,000, the commission to the employee is then $5,000.
As it relates to variance, a sales rep might have a killer month and make $10,000 in that pay period but next month only $8,000. What does a lender then do to get to the qualifying amount? Lenders understand how salespeople get paid and know the monthly amounts will be different. This is why lenders ask for the last two years income tax returns in addition to the most recent paycheck stubs.
The last two years tax return income information will be averaged. If in year one the income shown on the return is $100,000 and year two is $125,000, lenders will add those together to arrive at $225,000 and divide by 24 (months) to arrive at a qualifying amount. In this instance, the qualifying amount is then $9,375 per month. Lenders also want to see some consistency from years one and two. If year one shows $100,000 and year two is $125,000, this is relatively consistent.
It also points to an increasing income instead of the other way around. $125,000 back down to $100,000 isn’t that much of a drop so the lender won’t pay much attention to it and move forward with averaging. However, $125,000 to $85,000 will give a lender pause. So much so that the lender will need some convincing to explain the reason for such a drop and also some convincing that the drop was temporary and unlikely to continue. An extended illness, marital issues or a temporary furlough would be some reasonable explanations.
One other very important thing lenders look for with commission-based income. Salespeople can often have unreimbursed business expenses. These expenses will need to be deducted from qualifying income. For example, a sales rep has several accounts serviced each month. This can mean deductions such as entertainment expenses, a common deduction. Such expenses include those for meals, golf outings and mileage deductions when the car is used for work. Are there any dues or subscriptions the sales rep must pay directly related to the job? These also must be deducted from qualifying income. These expenses reduce the tax liability each year but at the same time can be deducted from the income needed in order to qualify for the home that person is looking at.
There are a few more steps to take when underwriting a loan application for someone who gets paid on commission. If you’re not sure how to calculate your qualifying income, your loan officer will do that for you. This is something you want to know before you get too much further in the approval process.
