Mortgage lenders look for two main things when reviewing loan applications: borrowers’ likelihood of repaying the loan, typically determined by their credit score, and their ability to do so, which is typically determined by proof of income.
Even if they have impeccable credit, borrowers still have to prove their income is enough to cover monthly mortgage payments.
Fortunately, there’s a range of mortgage loans, from government-assisted loans to the conventional fixed-rate type, designed for people with various financial needs.
“We’re not limited to one type of borrower,” says Houtan Hormozian, vice president at mortgage brokerage Crestico Inc. “There’s no standard when it comes to someone’s income. There are some college graduates who qualify for a loan with just one pay stub.”
Still, there are some basic standards that borrowers should be aware of before they start shopping for a mortgage.
Fannie and Freddie minimum income guidelines
When underwriting conventional mortgage loans, most lenders follow the guidelines of Fannie Mae and Freddie Mac.
Fannie and Freddie’s list of acceptable income documentation is extensive, but it isn’t set in stone. For example, if you have a relationship with a bank that knows your history and thinks you’re good for a loan, you might be able to secure a mortgage without meeting every standard requirement.
Navy Federal Credit Union is an example of an institution that considers a customer’s relationship with the institution.
“We’re open to considering loans for customers who might not meet normal standards,” says Randy Hopper, former senior vice president of mortgage lending with the credit union.
There are also borrower programs that deviate from standard income requirements.
For example, FHA loans have no specific income requirements. For these loans, lenders look at how much income is eaten up by monthly bills and debt service, as well as your employment track record. A borrower’s salary doesn’t play a big role in FHA underwriting, though typically, a lender will assess applicants with higher salaries as less-risky borrowers.
Borrowers reporting income from second jobs must provide tax documents in support. Those who are self-employed usually have to show proper tax documents and complete Fannie Mae’s Cash Flow Analysis, or another similar tool as part of their application.
For the most part, however, borrowers should have these documents are in order:
- For base pay, bonus pay and commission income equaling less than 25 percent of the borrower’s total annual employment income, a completed Request for Verification of Employment (Form 1005), or a recent pay stub and IRS W-2 forms covering the most recent one-year period
- If earned commission tops 25 percent of the borrower’s total yearly income, then either the 1005 or the borrower’s recent pay stub and IRS W-2 forms, as well as copies of the borrower’s signed federal income tax return
What kinds of income qualify for a mortgage?
Fannie Mae guidelines allow the following types of income to qualify for a mortgage:
- Base pay (salary or hourly)
- Bonus and overtime
- Secondary employment income (if you have more than one employer)
If you’re self-employed or work as a freelancer, you might qualify for a mortgage if you have tax returns that reflect self-employment earnings for the last 12 months. However, some applicants are required to have at least two years of these earnings to be considered for a mortgage.
Fannie Mae also lists more than 20 non-employment income types as acceptable forms of income. The borrower must supply the required documentation to support these income claims. These income types are an important consideration because the more funds you have coming in, the more likely you are to qualify, assuming that your credit score and debt-to-income (DTI) ratio meet standards.
Some non-employment sources of income that lenders might consider include dividend income, retirement income, alimony, child support, boarder income, royalty income, Schedule K-1, foster care income, trust income and Social Security payments.
DTI ratio to qualify for a mortgage
Like the income requirements, the requirements for a borrower’s DTI ratio are not set in stone, according to Fannie Mae’s guidelines. There are a number of variables that determine what a borrower’s DTI should be. For example, Fannie Mae requires that a borrower’s DTI can’t exceed 36 percent of their stable monthly income. However, that maximum can go up to 45 percent if the borrower meets credit score and reserve requirements.
Hormozian recommends paying off as much debt as possible to maximize your DTI.
“If you can move in with your parents while you pay off your car or some small student loans, I say go for it,” Hormozian says. “This is a good way to save money for your down payment while also reducing your debt.”
Other factors that matter when qualifying for a mortgage
Beyond your income and DTI ratio, lenders will also look at these factors when evaluating your application for a mortgage:
- Credit score – While you don’t need perfect credit to qualify for a mortgage, a higher credit score generally gets you a lower interest rate.
- Down payment – For conventional loans, the down payment requirement can be as low as 3 percent.
- Assets and cash reserves – Some lenders require you to have an adequate amount of reserves to cover mortgage payments after you make the down payment. Aim for three to six months’ worth, even if they require less, so you’ll be prepared in the event of an emergency.
Consult with a loan officer before applying for your mortgage. Your loan officer can advise you on conventional loan income requirements, how much income is needed for a mortgage and other eligibility criteria you should meet to increase your approval odds.
With additional reporting by Allison Martin