A Comprehensive Guide to How Mortgage Lenders Calculate Income

Whether you’re ready to jump into homeownership or are looking at refinancing your existing mortgage, knowing how your income factors into a home loan and understanding how mortgage lenders calculate income are important.

It’s easy to get confused as you navigate the home loan qualifying process. Mortgage Lenders Underwriters need to review a lot of information about you and your finances before they can determine what you can afford for a mortgage or refinancing loan. And there’s more to that equation than the money you receive from your paychecks.

Define seven types of income your mortgage lenders

Understanding the different types of income reviewed as part of qualifying for a home loan can be very helpful, so we’ll define seven types of income your mortgage lenders underwriters are looking at

  1. Salaried income
  2. Hourly income
  3. Bonus income
  4. Commission income
  5. Self-employed income
  6. Retirement income
  7. Miscellaneous

The first two types of income are salaried income and hourly income. These two are very similar in that both are money you receive from paychecks. A salaried worker’s monthly income is determined by dividing their total salary by the 12 months of the year. If an hourly worker has a steady paycheck with identical hours logged each pay period, their income will be treated in a similar fashion to a salaried worker.

However, if an hourly worker is logging a different amount of hours each pay period—perhaps 37 hours one week then 25 hours the next—then they will be considered a variable income employee. In this case, lenders will look at two years of income information and take an average of that data to get a more accurate picture of their financial health. It can be frustrating and confusing, especially if the amount of hours you’re working has increased year after year, but it’s something to keep in mind. There are ways to get around that two-year income review. You can acquire a guarantee letter from your employer stating that you are guaranteed a certain number of hours per week, which adds stability to your income.

Some types of hourly jobs also pay shift differential, meaning you make more per hour depending on the type of shift (getting extra pay for working nights or weekends for example). Again, lenders want to see proof of that shift differential and will average that income over a two-year period. That’s why it is so important to understand how mortgage lenders calculate income. The same thing goes for people who are pay fluctuates based on who they are working for. For example, you might have a base rate of $20 per hour, but when you work hours on a government contract, you make $40 per hour. Unless you have been paid that $40 per hour for two years, lenders will use the $20 figure in their calculations.

Next up are bonus income and commission income. These types of income are typically rewarded based on work performance and meeting company goals or quotas. And like the hourly pay earned by variable income workers, they need to be received for two years in order to be averaged and included in your total income. Say you worked at a car dealership in a commissioned sales role but left that position for one in pharmaceutical sales where you receive a salary and a bonus. Unfortunately, that bonus won’t be factored into your income for your home loan unless you’ve been at the job for two years. On the other hand, let’s say you make the jump to another dealership for a commissioned sales job instead. In that case, you need to be at your new employer for one year before that commission money is factored into your overall income.

Next on the list is self-employed income. People that fall under this umbrella include workers such as real estate agents, freelance consultants, and people who own an incorporated business. This is one of the most complicated types of income and people in this category tend to receive a lot of help from loan officers when it comes to getting their home loan application in order. When you’re self-employed, the profitability of your enterprise factors into your overall income—even if you are giving yourself a W-2 form at the end of the year. The key is to work with a loan officer that has experience assisting self-employed individuals.

That brings us to retirement income. When you retire, your income starts to change. You’re no longer receiving a paycheck but instead may be receiving a pension, drawing from Social Security, or receiving contributions from an IRA or 401(k). In order for this money to be calculated into your overall income, you need to receive income from these sources for—you guessed it—two years. There is a loophole of sorts with this income option. If your retirement account is large enough, you can work with your financial advisor to receive withdrawals on a set schedule that, in a sense, mimic a paycheck. If you can prove that you can receive this income for three years, you can qualify for a mortgage or refinancing.

The last category of miscellaneous income is a catchall for any remaining types encountered by loan offers. Some of the most common types are child support, alimony, rental income, or interest income from a large account. They can be used toward calculating a home loan, but there are rules and regulations around that use. Take child support for example. Loan officers will want to see your children’s birth certificate to verify the amount of time you expect to receive this income.

Having an understanding of what types of income mortgage lenders and underwriters will review and how mortgage lenders calculate your income will help prepare you for the home loan process and allow you to purchase or refinance your home with minimal frustration and confusion.

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