Orange County Calif 1st Time Homebuyers are finding that the number of available homes for sale has shrunk to the point where making an offer and getting it accepted is a competition. As in any competition, the strongest competitor will almost always win. In the case of purchasing a home, you become a strong contender by making sure that your financing is in place before you make that offer.
The process of securing financing is not as simple as filling out an application and 5 minutes later receiving an answer. There are significant steps involved in becoming mortgage ready and this is part two:
Check Your Income!
Your income is part of the formula used to determine how much money a lender can loan you. This can be either a very straightforward process, or it can be more complex, depending upon the source and structure of your income.
Lenders categorize income differently depending upon how compensation is earned. The goal for 
evaluating income is to arrive at basis for “Stable and Predictable Income.”
The easiest type of income to assess for stability and predictability are earnings based either on a salaried position or an hourly position with a two year history.
However, there are different types of compensation structures depending upon the type of work a client does…some may earn a base salary plus commission, some may earn commission only, some may earn a base salary plus bonus. These are all grouped in a category called “Variable Income” and require more documentation then a salaried/hourly wage earner.
Let’s explore two different examples:
Borrower 1 is a School Teacher and earns a salary of $84,000 per year which is reported on a W2 at the end of the year.
This is an example of a very straightforward income calculation where we take the $84,000, divide by 12 and use $7,000 (less any unreimbursed expenses filed on a 2106 form with income tax return) as the qualifying income.
Simple enough, right?
Borrower 2 also earns $84,000 per year but the compensation structure is different. Borrower 2 earns a base salary of $48,000 plus commission earnings, in this case $36,000. Moreover, borrower 2 has only been on this kind of compensation structure for a year and a half and prior to that time earned only salaried wages.
Can we perform the same calculation to give this borrower a $7,000 per month credit for income?
The answer for the most part is no…variable income such as commissions must be supported by a minimum two year history of earnings. In this case, the income calculation would look something like the following:
| Total commissions earned – prior 12 month period: |
$36,000 |
| Total c omissions earned – current 6 month period: |
$18,000 |
| Total commissions earned – 18 month period: |
$54,000 |
| Income averaged over 24 months: |
$2,250 |
| Base salary of $48,000 divided by 12: |
$4,000 |
| Total monthly income for loan purposes: |
$6,250 |
The reason for this is that many lenders take a conservative approach to calculating variable income by averaging the income over 2 years. This means that even though the variable income may be consistent during the past 18 months, the prevailing guideline is that “two or more years of receipt of a particular type of variable income is recommended.”
Underwriters do have the freedom to credit the full amount of variable income that falls between a 12-24 month period “as long as the borrower’s loan application demonstrates that there are positive factors that reasonably offset the shorter income history.” In reality in today’s market, most underwriters are going to require that we take the more conservative approach.
Because the criteria for qualifying for a mortgage is complex, it is important that you contact a loan professional to obtain a pre-approval before you make that all-important offer on your dream home.
For more information and a no-pressure conversation about your ability to qualify for a loan, give me a call at (714) 403-2603 or send an email message to Linda@LindaOnLending.com.
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