Qualifying income is a critical concept lenders use to evaluate whether you can afford a mortgage or other loan. It represents the reliable portion of your income that a lender expects you to continue earning, based on evidence such as W-2s, pay stubs, and tax returns.
How Lenders Determine Qualifying Income
Lenders aim to comply with the Ability-to-Repay rule mandated by the Consumer Financial Protection Bureau, focusing on income that is stable, reliable, and recurring. For salaried employees, this process is straightforward—verified by recent pay stubs and W-2 forms. However, borrowers with variable income like freelancers or commissioned salespersons often must provide at least two years of tax returns to demonstrate consistent earnings.
Common Types of Income Considered
- Salary/W-2 Wages: Viewed as most stable; easily verified.
- Overtime and Bonuses: Counted if consistently earned over the past two years.
- Commission: Requires a two-year history for averaging.
- Self-Employment Income: Net income after business expenses, verified via personal and business tax returns spanning at least two years. See our article on Self-Employment Income for details.
- Rental Income: Typically, lenders count 75% of gross rental income to account for vacancies and expenses, supported by lease agreements and tax returns. Learn more in Rental Income.
- Child Support and Alimony: Counted if court-ordered and consistently received, with anticipated continuation for at least three years.
- Social Security and Pension: Very stable; requires official award letters.
- Investment Income: Included if stable over time, documented by investment statements.
Why Your Qualifying Income Might Be Less Than Your Actual Income
Several factors can reduce qualifying income:
- New side businesses without two years of history.
- Unreimbursed work expenses that reduce net income.
- Cash-income not reported on tax returns.
- Irregular or one-time bonus payments.
Impact on Debt-to-Income (DTI) Ratio
Your qualifying income is key in calculating your DTI ratio, which compares your monthly debt payments to your gross monthly qualifying income. Most lenders prefer a DTI below 43% for mortgage approval. A higher qualifying income lowers your DTI, making you more attractive to lenders. Read more about Debt-to-Income Ratio.
FAQs
Can my spouse’s income count? Only if they co-sign the loan.
Will a new job hurt my qualifying income? Lenders consider job stability; a new job in the same field with a steady salary is generally acceptable.
Can non-taxable income be adjusted? Yes, lenders may “gross up” non-taxable income like Social Security by 15-25% to factor into qualifying income.
Authoritative Sources
- CFPB’s Ability-to-Repay Rule: https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/ability-to-repay/
- Fannie Mae Selling Guide on Income: https://selling-guide.fanniemae.com/Selling-Guide/Origination-underwriting-and-closing/3/General-income-information-63.htm
- For more on DTI, see Investopedia’s DTI article: https://www.investopedia.com/terms/d/debttoincomeratio.asp
