Mortgage lenders look for two main things when reviewing loan applications: borrowers’ likelihood of repaying the loan, typically determined by their credit score, and their ability to do so, which is typically determined by proof of income.
Even if they have impeccable credit, borrowers still have to prove that their income is enough to cover monthly mortgage payments.
Fortunately, there’s a range of mortgage loans, from government-assisted loans to the conventional fixed-rate type, designed for people with various financial needs.
“We’re not limited to one type of borrower,” says Houtan Hormozian, vice president at mortgage brokerage Crestico Inc. “There’s no standard when it comes to someone’s income. There are some college graduates who qualify for a loan with just one pay stub.”
Still, there are some basic standards that borrowers should be aware of before they start shopping for a mortgage.
Fannie and Freddie minimum income guidelines
When underwriting mortgage loans, most lenders follow the guidelines of Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Corp.).
Fannie and Freddie’s list of acceptable income documentation is extensive, but it isn’t set in stone. For example, if you have a relationship with a bank that knows your history and thinks you’re good for a loan, you might be able to secure a mortgage without meeting every standard requirement.
Navy Federal Credit Union is an example of an institution that considers a customer’s relationship with the institution. “We’re open to considering loans for customers who might not meet normal standards,” says Randy Hopper, former senior vice president of mortgage lending at Navy Federal.
There are also borrower programs that deviate from standard income requirements.
For example, Federal Housing Administration (FHA) loans have no specific income requirements. For these loans, lenders look at how much income is eaten up by monthly bills and debt service, as well as your employment track record. A borrower’s salary doesn’t play a big role in FHA underwriting, though typically, a lender will assess applicants with higher salaries as less-risky borrowers.
People reporting income from second jobs must provide tax documents in support. Those who are self-employed usually have to show proper tax documents and complete Fannie Mae’s Cash Flow Analysis, or another similar tool as part of their application.
For the most part, however, borrowers will want to make sure these documents are in order:
- For base pay, bonus pay and commission income equaling less than 25 percent of the borrower’s total annual employment income, a completed Request for Verification of Employment (Form 1005), or a recent pay stub and IRS W-2 forms covering the most recent one-year period are required.
- If earned commission tops 25 percent of the borrower’s total yearly income, then either the 1005 or the borrower’s recent pay stub and IRS W-2 forms, as well as copies of the borrower’s signed federal income tax return.
Non-employment income types
Fannie Mae lists 26 non-employment income types as acceptable forms of income. The borrower must supply the required documentation to support these income claims. These income types are an important consideration because the more funds you have coming in, the more likely you are to qualify, assuming that your credit score and debt-to-income ratio meet standards.
Some sources of income that lenders may consider include alimony, boarder income, royalty income, Schedule K-1, foster care income, trust income and Social Security payments, to name a few.
Debt-to-income ratio to qualify for a mortgage
Like the income requirements, the requirements for a borrower’s debt-to-income ratio, or DTI, are not set in stone, according to Fannie Mae’s guidelines. There are a number of variables that determine what a borrower’s DTI should be. For example, Fannie Mae requires that a borrower’s DTI can’t exceed 36 percent of their stable monthly income. However, that maximum can go up to 45 percent if the borrower meets credit-score and reserve requirements.
Hormozian recommends paying off as much debt as possible to maximize your DTI.
“If you can move in with your parents while you pay off your car or some small student loans, I say go for it,” he says. “This is a good way to save money for your down payment while also reducing your debt.”