Stated-Income

Is Gross Income Before or After Taxes?

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When you apply for a mortgage, your lender will ask about your gross income. You might be surprised to learn that this isn’t the money you bring home on your paycheck. It’s the full amount of your income before taxes and other deductions.

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Keep reading to learn why lenders use this number and which number you should use for your own budget.

Why Lenders Use Gross Income

The main reason lenders rely on your gross income rather than the net income is its reliability. Your net income is your total salary minus taxes and other deductions. These deductions could change often, so using your net income might give lenders inconsistent results. For example, if your company changes insurance plans or you change your tax filing status, your net income may change. Even if it’s only a $100 difference, it may still alter your ability to secure a loan.

Another reason lenders use gross income is that it’s a number you likely know off the top of your head. If someone asks you how much money you make per year, you probably know the salary your employer pays you better than the amount of your paycheck and how it converts into your annual salary. For example, it’s much easier to rattle off $75,000 per year rather than figuring out how your $5,267 monthly check converts into an annual salary.

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How Lenders Use Your Gross Income

Lenders use your gross income to determine the maximum amount of your loan payment. Each loan program is different, but as a general rule, you can use the conventional loan guidelines of 28% and 36%. In other words, you can have a mortgage payment that is up to 28% of your gross monthly income. But lenders will also look at your total debt ratio. This is the total of all of your monthly debts including your mortgage payment – this figure shouldn’t exceed 36% of your gross monthly income.

Why You Should Focus on Net Income

Now just because a lender focuses on your gross income doesn’t mean you should use this figure. Your net income is the money you actually take home. This is the money you can use to pay your bills. You want to make sure that the mortgage payment you take on fits into that budget.

A good way to figure it out is to put the potential mortgage payment into your monthly budget. Are you comfortable with the payment? Do you have enough money left over after paying your bills to cover your living expenses?

If you focused on your gross monthly income, you might take on a mortgage payment that exceeds what you bring in or what you can comfortably afford. Some people don’t want to take on debts that eat into their disposable income. Many borrowers don’t want to live paycheck-to-paycheck. These are all reasons why you should focus on the net income to make sure you are taking on a loan you can afford.

Your lender will focus on your gross income, so make sure you have those numbers handy when you apply for a loan. But when you think about what you can afford, your net income is a better figure to consider to ensure that you only take on what you can afford.

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What Is a Good Expense Ratio for Self-Employed Home Buyers?

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In order to get a mortgage, you need to show that you are not a high risk to lenders. This means good credit, stable income, and a good expense ratio. What if you are self-employed though? How does this relate to you?

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Self-employed borrowers are at a bit of a disadvantage. They are automatically considered ‘high risk,’ because their income can be so erratic. The longer you are self-employed, the less risk you pose to a lender. However, you still need a high credit score, proof of stable income, and what a lender considers a good debt ratio.

Let’s look at the debt ratio further.

The Magic 43% Number

You’ll likely hear the number 43% pertaining to debt ratios quite often. That’s because it’s the magic number that allows a mortgage to be considered a Qualified Mortgage. Just what does that mean? It’s protection for the lender. It shows that the lender did its due diligence and did not give you a loan that made your total monthly debts exceed 43% of your gross monthly income.

Unfortunately, for some, that 43% is hard to hit. Luckily, not all lenders require only Qualified Mortgages. It’s not uncommon for self-employed borrowers to have a debt ratio as high as 45%, but that’s typically the maximum. It means that almost half of your income goes towards your monthly bills. That leaves only 55% of your income for daily living expenses and savings.

The Factors Other Than the Expense Ratio

Believe it or not, there are other factors lenders consider when deciding if you qualify for a self-employed mortgage. For starters, they look at the stability of your business. They look at:

  • How long you have been in business?
  • The stability of your income in that business (does it increase or decrease year over year)
  • What is your experience in the business like?

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The answers to these questions help a lender determine your income stability. Let’s say you have owned your business for 3 years. The first year you had a decent amount of income, but the year after that your income declined, and the year following that it declined again. This does not prove promising to a lender. They would much rather see increasing or at the very least, steady income to help ensure that you can afford a loan. Even with a 43% or lower expense ratio, if you have decreasing income, your chances of securing a mortgage are not very high.

Of course, lenders also look at your credit score. Your income shows how much you can afford, but your credit score shows your financial responsibility. What is your credit history like over the last 2 years? Do you have a lot of defaulted debts and late payments? If so, you prove risky to a lender. They want to see a pattern of paying bills on time and not overextending yourself financially.

Finally, lenders look at your assets. They want to know that you have another way to pay your mortgage should your income falter from your business. Let’s say you have a bad 3 months in your business. Do you have money to cover your mortgage payment set aside? Lenders call these reserves. They want to know how many months of your mortgage payment you can cover with your assets. This gives them peace of mind that you won’t default on your loan no matter what happens to your self-employed income.

It’s a Big Picture

Lenders look at all factors of your application as a big picture. They put all of the pieces together to determine your risk level. Just having a great expense ratio isn’t enough. You can have a low debt ratio and still have a low credit score and unstable income.

Instead, lenders want it all to come together. You might have a slightly higher expense ratio, but have a great credit score and steadily increasing income. If you can prove you have what it takes to survive in the industry you are in, a lender may grant an exception for your slightly higher debt ratio.

Just how high will a lender go? It depends on your situation. Again, looking at all of the factors, a lender will decide. Of course, no two lenders have the same requirements. Even two conventional or FHA lenders may have different requirements. They can add overlays onto what the program requires. One lender might not see a problem with taking a 45% debt ratio, while another may want nothing to do with it.

The key is to shop around and find the deal that works best for you. Don’t assume you need a specific expense ratio or you won’t get a loan. Make your other factors as attractive as possible. Increase your credit score, stabilize your income, and make sure your income steadily increases (not decreases). The combination of all of these factors can help you get the loan you need as a self-employed borrower.

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Is it Possible to Get a Stated Income Loan for Investment Properties?

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Most banks are happy to finance investment properties for borrowers who have less than four mortgages under their name. Unfortunately, they frown on applicants who have problematic credit history, short employment history, have more than four investment properties in their portfolio, or those who have unconventional sources of income. Can the stated income option come to the rescue?

Stated income loans have their roots even before the housing crisis. In fact, they used to be very common, despite the high risk they carry. The accumulation of these non qualified loans led to the housing collapse in 2008, leading lenders and borrowers alike to shy away from such offers. However, they didn’t disappear altogether.

How do you get a stated income loan?

In the years that followed, stated income loan offerings shrunk but as the years erased the trauma of the previous crisis and more demand kept coming in, lenders began to see the profit potential in the underserved borrower market. Today, such loans are making a comeback. Are they safe? Experts suggest that these loans aren’t the same as their predecessors because of more stringent underwriting standards. Stated income loans today may be harder to qualify than their their subprime counterparts pre-recession.

If you get turned down by big banks on your investment property financing application, you can look to lenders such as:

  • Local Portfolio Lenders. These lenders lend their own money and don’t sell their loans to the secondary market.
  • Hard Money Lenders. They specialize in providing loans for fix and flips or rental properties for a short period of time.
  • National Lenders. These lenders specialize in financing rental properties.

Why is it hard to get a loan on investment properties?

After the 2008 recession, the government established rules that required strict underwriting requirements to make sure the borrower can repay the loan. This wasn’t the case before the crisis. Lenders used to provide loans even without verifying a borrower’s income.

This made it difficult for many borrowers who have the money but can’t establish the proper proof that they can, indeed, pay for the loan. Most of these borrowers have huge debt-to-income ratios due to the huge amount of credit on their name. Many of these investors also take huge deductions on their taxes. If your taxable income is too low, you’ll have poor chances of getting a loan. And even if the borrower does manage to get a loan, there’s another set of barriers to refinancing.

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What other benefits can I get from getting a mortgage under alternative lenders?

Most local portfolio lenders do not care if your properties are under your name or an LLC. Most banks require a property to be under the investor’s name which can pose a problem if he or she is trying to limit liability. A strategy that most investors follow is to transfer their properties to an LLC when they finance with a bank later. Unfortunately, the banks can call the loan due when the property is sold and transferring the property to an LLC is basically selling it. This complication is avoided with certain stated income lenders.

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Income Matters: How Much Is Required to Qualify for a Mortgage?

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Forget down payment for now. When you plan to get a mortgage, one of the very first things to consider is your ability to repay this debt. That’s why, verification of income on all mortgages, stated income loans included, is an essential step to get approved for the mortgage.

Lenders primarily want to know if you have a steady and reliable income to support your monthly payments. When can a lender say that you are making enough to be able to afford your loan payments? How do you determine this income required for a mortgage?

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Understanding Income and Mortgage

Stated income loans of yesteryears can attest to this. A decade ago, it was easy to make loans based on the borrower’s word that he/she is earning this much. The stamp of approval did not rely on any verification.

But that’s highly unlikely now. Stricter rules and policies are in place to ensure loans are safe for consumers and lenders. Today’s stated income loans, for example, may forgo tax returns, but alternative documentation like assets and bank statements will be verified.

Income’s importance in mortgage qualification can’t be emphasized enough. And how much you need in order to qualify is a combination of several factors.

Calculating Income Required for Mortgage

To determine the level of income you need to qualify for a mortgage, consider the following:

  1. Monthly housing expenses. This is what you spend on housing, e.g. mortgage payment — principal, interest, property taxes and homeowners insurance (one-twelfth), homeowners association fees — or rent.
  2. Monthly liabilities. This refers to your total monthly expenses, housing and other debt obligations such as car loans, student loans, alimony/child support, and payments on loans that you are a co-borrower to. Utilities are not included.
  3. Mortgage amount. The amount you need to borrow for your home loan.
  4. Mortgage rate. The interest that you’ll receive on your mortgage. If you are getting a fixed-rate mortgage, this won’t change throughout the life of the loan. For an adjustable-rate mortgage, the start rate will adjust periodically. You can get pre-approved to get a definite rate from the lender or shop for mortgage quotes for now here.
  5. Mortgage term. The length of time to pay off the loan. This affects the calculation of your monthly principal and interest payments.

There are online calculators that will crunch the numbers based on those variables.

Knowing Your DTI

Where does your current monthly income fit in all of this?

Lenders use debt-to-income ratio to measure your ability to comfortably take on the loan given your total monthly liabilities including housing costs as noted above and your gross monthly earnings.

To get this DTI, you’ll divide your monthly liabilities by your monthly income before taxes. Your DTI calculation may be different from that of lenders because not all sources of income may be qualified for mortgage purposes.

Nonetheless, your DTI ratio will be your guide in determining your capacity to afford a mortgage for now. Lenders and loan programs have varying standards for DTI ratios. Most recently, Fannie Mae has expanded its maximum allowable DTI ratio to 50%.

Qualifying and verifying income are two different processes and lenders are the best people to ask about their rules. Speak with one today.

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Understanding the Debt-to-Income Ratio

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Understanding the Debt-to-Income Ratio

You may have heard of lenders offering jumbo loans for borrowers with 55% DTI. DTI stands for debt-to-income ratio, a loan metric as important as your credit score. For stated income loans, the DTI might not figure out that much compared to the size of the down payment and cash reserve and the level of the credit score. Nevertheless, it shows how much you owe relative to how much you earn and could cause lenders concern about your ability to repay your mortgage.

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Two Types of Debt-to-Income Ratio

There are two ways lenders look at and compute your debt-to-income ratio.

1. Front-end ratio. This calculates how much of your gross income, expressed in percentage, goes to housing. Thus known as the housing ratio, it takes into account the monthly payments on any mortgage (first and second), property taxes, homeowner’s insurance, mortgage insurance, and homeowners’ association fees, as applicable. Utilities are not included.

To calculate, divide the gross housing costs by the gross income, multiply by 100. Say your housing-related expenses total $4,000 and your monthly income is $10,000, your front-end DTI is 40%.

2. Back-end ratio. Also known as the total debt-to-income ratio because it sums up the housing expenses; all debts requiring monthly payments, including car loans, student loans, credit cards, mortgages on other properties and related taxes, insurance and HOA fees; child support; alimony; and more.

For example, your housing expenses plus your other monthly debts add up to $5,500. Divide this by $10,000 and multiply 100 and you’ll get a total DTI of 55%.

What Is (Not) Considered Debt?

For a more accurate DTI, it must take into account all the monthly payments you make. The following obligations are not considered debt and are thus not subtracted from your gross income as listed by the CFPB:

  1. Automatic deductions to savings accounts
  2. Child care
  3. Commuting costs
  4. Federal, state and local taxes
  5. FICA (Federal Insurance Contributions Act) or other retirement contributions, e.g. 401(k) accounts
  6. Open accounts with zero balances
  7. Union dues
  8. Voluntary deductions

Lenders and loan programs will still vary on calculating qualifying ratios for a mortgage. Always ask lenders. You can find them here.»

DTI for Stated Income Loans

There is no set maximum DTI ratio for stated income loans. It’s possible to have a DTI ratio of the total monthly income to the total monthly debt beyond 43%, all things considered.

Back in the days when the original stated income loans were all the rage, lenders were more strict with DTI. It’s because the income stated on the loan must have a DTI whose numbers add up.

There’s also the issue of the income matching the job description of the borrower. As in the case now, if your stated income is too high for your position, the lender may deny your loan application or ask for further documentation, making it a full doc loan.

Needless to say, your DTI should match your stated income.

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