When a lender offers you financing for a home or other loan, it's usually worried about one thing -- getting paid back. One of the ways it calculates the chance of you paying it back is by looking at your income. The more you make, the more you have that you can use to pay off your loan, and the more likely a lender is to work with you. However, some types of deductions can impact your income and debt profile, which can raise alarms with a lender.
Mortgage lenders use a statistic called a debt-to-income ratio to decide whether or not to finance you. They calculate it by dividing your monthly proposed mortgage payment into your monthly income. Lenders also calculate a back-end ratio by dividing all of your monthly debt payments into your income. If the percentages are too high, they won't make the loan. While the ratios vary by lender, the Federal Housing Administration's low-down-payment mortgage program usually caps the mortgage payment at 29 percent of income and caps total debt payments at 41 percent.
Calculating Monthly Income
When you work a traditional job, calculating your monthly income is a relatively simple process. All that you have to do is divide your salary by 12. If you make $36,000 per year, your monthly income is $3,000. If you have a business, though, your income is calculated based on your business's profits instead of your gross income. For a mortgage lender, getting money from working on gigs as a contractor is considered having a business, so you may be a business owner even though you don't realize it.
Tax Return Review
Generally, lenders look at your income on a pretax basis, so personal deductions that you claim aren't a factor in calculating your debt-to-income ratio. However, your mortgage lender may also want copies of your tax returns as a part of reviewing your application package in its underwriting process. When it reviews your tax returns, it's looking for irregularities that could impact your income. One deduction that could cause trouble is if you write off expenses that you incur at your job that you don't get paid for by your employer. Your lender may subtract these unreimbursed expenses from your income, reducing your ability to qualify for a loan.
Contracting and Consulting Gigs
If you do individual work projects and get paid without having taxed withheld, you have the ability to write off all of your own deductions. The more legal deductions you take, the less you pay in tax, which saves you money. However, when you take a deduction against your gigs' income, you're also reducing your profits. The less profit you earn, the lower the income factor will be in your debt-to-income ratio, and the harder it will be to qualify for a loan.
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