Back to Fundamentals: How do I know how much mortgage payment I qualify for?

By: Evan Vanderwey
Michigan Mortgage

The answer to this question defines the “simple but not easy” category of mortgage education if ever there was such a category.

Simply put – you take your gross monthly income, multiply by around 40% (0.40), subtract from that number the amount of the minimum payments on all of your other debts, and the resulting number is the amount of your maximum house payment. Lastly, the house payment must include the principle and interest amount, property taxes, home owners insurance, and association dues if you are buying in a condominium complex.

Simple.

Except for one thing: What does the lender consider to be your gross monthly income?

Here’s a little help if you’re trying to calculate your gross monthly income. But if you are serious about putting in an offer on a home, there is no way a seller or your REALTOR® will trust your own calculations. In this market, if you’re using a mortgage, you will be required to talk with a lender who will sign off on your math ahead of time.

If you are employed and are paid a salary then you take your gross annual salary and divide by twelve. This is your monthly income.

If you are paid a bonus annually – you take the last two years’ amounts, add them together and divide by 24. Unless your most recent year’s bonus is less than the one you got two years ago – in that case, you take the last year’s amount and divide by 12.

If you earn overtime, consider ignoring it when it comes to setting your personal budget. But if you need to include it to qualify for the mortgage, then it must be increasing from year to year and then you take a 24-month average of the amount of overtime you earned.

Commission-type income must be taken as a 24-month average as well and can be used only if the income is increasing over the past two years. Under certain circumstances, declining income may be used, but only the lower of the two years is used in the calculation. Tax deductible expenses that are deducted on the person’s tax return (form 2106) must be removed before calculating the “gross taxable income.”

Self-employed borrowers must be able to show two years of income as well. We must see an increasing income pattern in most cases. Depreciation can be added back into this number. I cannot stress enough the importance of working with a knowledgeable loan originator if you are self employed. Your income must be calculated accurately up front or even the most well-qualified borrowers can find themselves with a difficult situation during the loan process.

For bonuses, overtime, commissions, and self-employment income, the borrower must have been in the same exact job for the past two years. You can’t move from GM to Fiat for example and average the last two years’ overtime over two separate employers.

Rental income from a tenant can be added in at 75% of the amount of the rent once there is 12 months of history of the tenant paying on time. We can also use the schedule E of a borrower’s tax return to verify rent – this takes the income from tenants and subtracts the expenses from that investment property. The net income on schedule E can be used after one year of having received the rent. Depreciation again is a non-cash expense and can be added back to net income.

Fixed income from settlements or awards, like child support and disability, pension or social security income, is all usable income. We use the full amount as gross monthly income so long as it can be proven that there are three years left for child or spousal support payments. There must be at least 12 months of proof that the payments have been received.

The above list is not meant to be exhaustive but instructive. Calculating income correctly for a lender is no easy task. Take this seriously and work with a qualified lender ahead of time.