When we discuss income, we will always refer to an individual’s gross income before they pay out taxes or social security or make any pre-tax contributions such as benefit premiums or 401K plan contributions. Income may come in many forms and from many different sources. The source of the income will determine what the bank will need to verify that income.
Salary /Hourly Rate
The most common source of income by far is people who receive a base salary or an hourly wage at their job. To verify this type of income a bank generally will need one or two years of W-2 forms and up to one month worth of pay stubs. This is usually sufficient to prove that the individual works at their job and is paid the salary that they claim to make. If you have been with your current company for less than 2 years, then the lender may consider the history of your earnings at your current level to show consistency.
Bonus/Overtime/Commission
With any type of non-standardized income, the lender will almost always require a two-year history. This can be proven by either the customer providing their year-end pay stubs for the last two years or by the lender contacting the employer to obtain an income history breakdown in writing. This type of written employer verification is known as a Verification of Employment (VOE or EV). If the non-standardized income has been increasing over the last 2 years, then the guideline dictates that it is averaged. If it was less last year than the year preceding, then the income from last year is used in an effort to be conservative.
With any employment, the lender will require a final verbal employment verification through the company no later than 3 days prior to closing. At this interview, they will not only ask that the applicant is still gainfully employed but that there is an “expected continuance of employment”. Therefore, it is highly advisable if you are planning on changing jobs to not give notice to your company until after your loan has been closed and funded.
Self Employed
If a customer is self-employed or works on a 1099 they will also be required to send in 2 years of tax returns. This is so the bank can view how much they are bringing forward, after deductions, to the front page of their federal tax return. One of the biggest issues run into is a self-employed entrepreneur or commissioned employee who takes all kinds of income deductions on their tax returns and, as a result, does not bring forward enough income to qualify under normal circumstances. Also, with these two types of people, the bank will almost always require a 2-year history of this kind of income and will take an average of the last two years to determine the income that they can use to qualify. If you have been self-employed or on a 1099 for less than two years you will have a much more difficult time getting a lender to look at that income.
Example: A commissioned sales rep is applying for a mortgage in 2022. They have carried forward $80,000 in 2020 on their personal return and $120,000 in 2021. The bank would take the average of these two numbers or $100,000 to qualify them for the loan for which they are applying.
In addition, self-employed borrowers will also be required to provide a year-to-date Profit and Loss statement on their business. This is simply to make sure that the business is maintaining profitability through the current calendar year. Generally, if your tax returns are strong for the last 2 years and you do not need this year’s income to qualify, you will be able to put together the P&L yourself. Otherwise, an accountant will have to provide you with an “audited” P&L if you need the income for qualifying.
A customer is considered self-employed if they own 25% or more of a business or corporation. If they own a corporation that files separate returns he or she will have to provide 2 years of corporate as well as personal returns. If they own less than 25% then K-1’s would usually suffice.
Other Income
Most other income such as note-receivable, child support, alimony, social security, disability, etc. must show an expected continuance of three years beyond the closing date. Generally, an award letter will be required and something such as evidencing that you are currently receiving this income.
