Capacity, credit, collateral, and capital are considered the 4 C’s of mortgage lending. Basically, these are the main areas lenders review to qualify a borrower. But these 4 categories are broken down into many subsets. This article is going to discuss the capacity to pay back the loan and more specifically discuss the role of employment history. While reviewing capacity, lenders will review a borrower’s income, employment history, assets, and debts to determine qualification. Employment history plays an important role when it comes to areas such as:
- Commission Income
- Overtime Income
- Bonus Income
- New Job
- Second Job
- Pastoral Income
- Self Employed Income
- Rental Income
Commission and Employment History – Don’t get Denied!
Whether paid partially or fully by commission, it provides employees with sales and results based income. Contrary to a salary or hourly employee, commission income fluctuates based on certain levels of production. Since commission varies, mortgage lenders will require a certain amount of history. By taking an average over time, a more dependable income is derived. Typically, mortgage rules require a 2 year employment history in a commission job. When 2 years are required, a commissioned employee with less time would actually have zero income as far as a lender is concerned! But, sometimes there are solutions for less than 2 years of commission income.
Less Than 2 Years of Commission Income
When there is less than 2 years of commission income, there may be a solution; Although there is a minimum of at least 1 year commission employment history. There are several home loan options for those with commission income like this. For instance, FHA and some conventional loans may allow just 12 months of commission income. No matter the length between 12 and 24 months, the total commission portion of income must be divided by the number of months receiving the income. Additionally, be aware that if commission income makes up 25% or more of the total borrower income, there is another step. Lenders must review the federal tax return for unreimbursed employee expenses. So if the returns show this expense, it must be subtracted from the commission income.
Although we see commission income more often in FHA and conventional loans, it could be possible to use less than 2 years of commission on USDA loans as well.
Bonus Income Employment History
Bonus income works very similar to commission income as it is based on achieving certain levels of production. Although a bonus may be every paycheck or as few as once per year. Just like commission income, lenders like to see a 2 year history of bonuses received. This is especially the case when a bonus is paid only once per year. It is hard to prove a history or even that the bonus will continue when someone has only received it once. Makes sense, doesn’t it? But if the bonus is received monthly or more often, the chances improve of counting it in shorter than a 2 year period. Finally, an important requirement in addition to a history of receipt is that bonuses must be “likely to continue”. If an employer states the bonus is “not likely to continue”, this would be an issue in counting it.
Overtime Employment History
Commission or bonus income is not the only way to make extra money. Overtime pays employees extra money (typically 1 1/2 times base hourly wage) for working over 40 hours. Most of the time, overtime is not guaranteed. Therefore, overtime is a fluctuating income as well. Again, this income must be averaged over a period of time to calculate a more dependable amount. Now, keep in mind that if an employee consistently works 40 hours a week, this income is considered dependable and should be counted. Even a brand new hourly rate increase may be counted immediately. But, overtime must be averaged. Actually, it is not unusual for us to average overtime for the prior year with the current year to date average. Therefore it is sometimes possible to count overtime when less than 2 years, although it helps to be closer to 2 years. Just like commission and bonus income, the likelihood to continue is important.
New Job May Not Require Employment History!
A common misconception is that in order to qualify for a mortgage, all borrowers must be employed for 2 years. This is often not the case! A lot of what we have spoken about deals with having sufficient employment history. But there are actually several cases where someone who has just started or WILL start a brand new job, may get mortgage approval. Common employment history occurrences include…
- Employment Offer or Employment Agreement
- Change of employer in same line of work
- New job after college
Job Offer Letter or Employment Agreement
Actually at the time of this article, we have a buyer who is relocating to a new, salaried job. So the tough part of moving to a new area is deciding where to live. Preferably, the buyer wants to buy a home and close shortly after starting the new job. The following was the timeline
- Employment start date August 15th
- Purchase contract provided August 4th
- First paycheck August 31st
- Purchase closing date August 31st
In order to pull this off, we build a quality file and submit it early for underwriting approval. Since the buyer had not officially started the job as of the underwriting submission date, we used the job offer letter to document the income. Once the borrower starts the job, we would get the employment verified. But many would ask “What about a paystub for loan approval?”. Well, in cases of a salary or even hourly like this, it is possible for us to close without a paystub. We could actually obtain the first paycheck after closing. But, for this one we will receive the paystub on the day of the closing. So, the final result is the buyer’s family is able to move into their new home shortly after starting the new job and no paystub was needed for obtaining final approval! Keep in mind that this is a case by case situation and it depends on the overall strength of the file.
Changing Employers But Staying in the Same Line of Work
Just like the example above, when employees change jobs in the same line of work, it is possible to have no history on the new job. To verify employment stability, we would verify the prior employment history. The new job basically needs to make sense. Was there a pay increase, shorter commute, or other tangible reason for the change? It is much easier to allow this employment change when the pay is salaried or base hourly pay. New employment with commission, bonus, or overtime income is very difficult to include. But, in certain cases with strong similarities to the prior job and assurances from the new employer, it may be possible to count variable income sources like these.
If considering the purchase of a home and a job change, it is important to discuss these with an experienced loan officer. Make sure not to assume that just because the job is the same type, that it will definitely be ok to switch. Plus, NO MATTER WHAT, do not change jobs during the mortgage process! Believe it or not, this happens way too often and even after warnings. Changing jobs during the loan process could at minimum cause closing delays and may even deny a mortgage loan. Again, stay in constant communication with your experienced loan officer for best results! Also, check out these important tips to avoid closing problems…
New Job After College
Believe it or not, a buyer may actually get approved with no employment history AT ALL. In the case where a buyer has just received a college degree and then starts a new job, the income could be counted right away. That’s right, no employment history and a new salary or full time hourly pay could be counted immediately. Basically, here is what would be looked for in these cases…
- Provide college degree
- Provide unofficial school transcripts
- Job related to degree
- College serves as employment history
- Salaried or base hourly pay allowed
To take it even further, it is possible to get a mortgage loan while in college and even while receiving no income. But, to accomplish this, there would need to be a borrower with sufficient income involved. The other borrower could be someone that would live in the home or even a co signor that would not live in the home. A co signor may be a family member or others.
A common occurrence these days is that graduating students have student loan debt. While these debts may be a large amount, mortgage programs have loosened how this debt is treated when it comes to qualifying. The most beneficial treatment of student loan debt includes Fannie Mae loans using income based repayment (IBR) payments reporting on the credit bureaus. The old way required lenders to count 1% of the balance or the future fully amortized payment. The new way is much better. Additionally, VA loans will even allow zero payments to be counted as a debt when the student loan payments are deferred greater than one year after closing. Furthermore, VA will also allow for a preferred calculation of IBR payments. Both allow for more qualifying buyers. FHA and USDA will use 1% of the outstanding balances or the fully amortized payment.
2nd Job Employment History
One area that is strict on employment history deals with counting multiple jobs. Holding down 2 jobs is tough to do. So in order to count a 2nd or even 3rd job, there must be a consistent history for at least 2 years. Basically, there cannot be any job gaps on either job to count the additional income. For instance, if someone has worked a primary job for 3 years and started a 2nd job 6 months ago, the 2nd income could not count. What if a year ago, the buyer held another 2nd job? Well, there would be a 6 month gap. So there would need to be more time on the 2nd job to count the income.
Pastoral Income & Housing Allowance
Unless you are a pastor, you may wonder why we are talking about this specific income. Well, the reason is that pastors across the U.S. constantly contact us about other lenders not understanding their income structure or employment history. First of all, pastoral income may be structured in many ways. But the most popular is receiving some level of base pay in the form of a W2. Additionally and the most misunderstood portion is pastoral housing allowance. A housing allowance is usually paid to a pastor in the form of a check which should be excluded from IRS taxes. For this reason, the additional income will not show up on the tax return. But, with sufficient documentation pastoral housing allowance may be counted on any mortgage product.
Self Employed Employment History
Business owners often cringe when it comes time to qualify for a mortgage. The main reason is that self employed income is calculated differently than a w2 employee. Lenders do not go by the gross earnings of a business, but by the net. Of course business owners very often want the bottom line to be as low as possible in order to pay less taxes. So this causes an issue when lenders go by that figure. Although there are some figures which potentially may be added back to be included in the bottom line.
Another area of concern may be length of time in business. Many entrepreneurs make the jump to being their own boss so that they can do it their way and build the better mouse trap. Typically lenders are looking for a minimum of two years of tax returns for calculating income. While using 2 years of tax returns, lenders will average the calculated income over 24 months. But, if the income is lower in the most recent year, the lower year may be used. If the drop is significant, the income may not be able to be used at all.
Self Employed Solution with One Year of Tax Returns
Recently we have been able to approve self employed buyers with only 1 year of tax returns! Now, it is tough for a business to turn a profit in the first year in business. But for those that do it, there could be a viable mortgage option. For a conventional or Fannie Mae loan, it is very possible to get this 1 year approval. Basically, the stronger the credit profile, assets, and other areas for the borrower, then the better chance of obtaining this approval.
Whether it is by choice or necessity, a lot of buyers may have a rental property. Maybe it is a recently converted primary residence or even currently buying a rental property. Depending on the scenario and loan type, often there are solutions to use new rental income to qualify.
Converting a Primary Residence to a Rental
Sometimes rather than selling a current home, a homeowner may decide to rent out the current home to buy another. Using this brand new rental income for qualification depends on the loan type. The good thing is there are several options. VA loans are the most lenient as new rental income may be counted up to 100% of the new rental agreement. Although if the gross rent exceeds the total mortgage payment, the extra profit may not be counted. Counting this rental income is huge, especially when it covers the rental property mortgage! Furthermore, if using a Fannie Mae conventional loan, 75% of the new rental may be used towards covering any existing mortgage, taxes, and insurance. FHA will use the same 75%, but in order to do this FHA requires an appraisal to prove the new rental property has at least 25% equity. Meanwhile, USDA will not allow new rental income as it requires a 2 year rental history on tax returns.
Purchasing a Rental Property & Using Market Rent to Qualify
Investing in real estate is getting more and more popular. Not only could it appreciate in value, but tenants are helping the landlord pay down the debt. Rental property purchases require a minimum of 15% down, but it is more popular and affordable to put down 20-25%. Qualifying for an additional property may be tough as another potentially large payment is being added to a borrowers debt ratio. But a huge advantage of buying a rental property with a Fannie Mae loan is that 75% of the market rent may be used to lower the debt ratio. Market rent is determined by the appraiser of the property. The appraiser compares the home to other rentals in the market and a monthly rental income is tallied. So for instance, if the appraiser says the market rent for the property is $1000, then 75% or $750 may be used as income for the buyer.
Rental Property Reporting on Tax Returns
If a buyer of a primary residence owns a rental property which already reports on tax returns, it is possible to be used as income. If not a profit, hopefully at least it helps offset part of the housing debt. Typically the most recent filed tax return may be used to calculate the net rental income. To find rental income, go to schedule E of the individual federal tax return. This is the page that lenders use to calculate rental income. But don’t just use the top or bottom line as there are items to add and subtract. Just let us calculate the rental income for you. When using tax returns for rental income, FHA does not require proof of equity in the rental. Keep in mind, USDA requires two years of rental income reporting on tax returns.
Contact Us for Employment History Solutions
As you can tell, there are a lot of options for newer employment history. So hopefully this article has shared helpful ideas for you. The important thing is to contact one of our loan officers for a discussion. Even if approval is not possible right now, a plan could be in place now for later.
Author: Russell Smith
Team Move OVM Financial loan officer success is Russell’s primary focus. He provides the tools and techniques he used as a top producing loan officer. Additionally he offers the Team Move OVM Financial Agent Training Program. Sharing is so important to Russell so he works diligently to be a resource to loan originators and Realtors.