Do You Know What Your Lender Looks For in a Loan Application? Part 3

In previous posts we’ve discussed the first two legs of the loan application: Credit History and Asset.
Part 3 is going to focus on the third leg of the loan application CH-A-I-R, Income.Where Credit History Financial Plan Example Pdf is concerned with your willingness to repay. Income is how the lender determines your ability to repay.
If you’ve been using one of the myriad of “how much do I qualify for?” applications on many lender’s websites, you’re probably getting misled by the results.
Why? Because unless you have lending experience, you probably aren’t calculating your income the same as a lender would. The exception being, if you are salaried and each paycheck is exactly the same.
If your salary is based on an annual figure, divide by 12 and go, otherwise it’s going take someone with lending experience to accurately calculate the number a lender will consider.
This article isn’t intended to teach you how to calculate income, but rather to better understand some general rules that lenders follow when determining which income can be included in the calculation and then how much they will use.
Lending rule #1 – If it’s not on your tax returns you can’t use it. Any income you have that is not reported to the IRS won’t be considered for loan qualification purposes. Stated income loans, like 8 track tapes and Oldsmobiles are things of the past, so undeclared tips, income from side jobs, your brother-in-law paying you back the bail money you lent him won’t be considered.
If you are self-employed or have un-reimbursed employee business expenses (Form 2106) your lender will use the income AFTER these deductions are taken.
The housing meltdown has created an alliance of sorts between lenders and the IRS. When you apply for your home loan, the lender is going to require you to sign IRS Form 4506T. This form allows the lender to verify that the tax returns you provided are the same ones you filed. Any discrepancies will result in a denial of your loan application and a good chance the IRS will come knocking for the difference.
We had a client who provided us tax returns showing income of $400,000 a year but filed returns showing $40,000. Needless to say his loan was declined and last we heard the IRS was looking for its share of $360,000.
Lending rule #2 – You must have a two year employment history (usually in the same line of work). Lenders are looking for consistency of income and job hopping in and out of various unrelated fields doesn’t make them “warm and fuzzy” about your ability to repay. Changing jobs in the same career path, especially when accompanied by increases in pay, isn’t necessarily a deal breaker, but be prepared to explain the dates and reasons for leaving.
Lending rule #3 – If you have “discretionary income”, that is income over and above your regular base pay, i.e. overtime, bonus, or commission, you will have to verify a history (usually two years) and a likelihood it will continue. If you have child and/or spousal support and want to include it in your income, make sure to let the lender know. These too will be subject to verification that they have been received consistently in accordance with the divorce decree.
Lending rule #4 – To maximize its chance of being repaid a lender is going to not only analyze your income but also make sure that you are not spending a disproportionate share of your income on your housing and credit debt. This relates to your payment-to-income ratio (top) and total debt-to-income ratio (bottom). Good “rules of thumb” are that your payment-to-income ratio should not exceed 33% of your gross monthly income and the total debt-to-income ratio should not exceed 45%.
Buying your first home is really just answering to basic questions:
1) What do you want to buy?
2) How are you going Business Loan Eligibility to pay for it?
The answer to question 2 will also give you the answer to question 1.
Next article – Reserves or “your skin in the game.”

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