One challenge for buyers and homeowners who want to refinance...

One challenge for buyers and homeowners who want to refinance is they must prove to the lender they have enough income to afford the payments. Credit:

One reason some home sales fall apart is the buyer can't qualify for a mortgage loan. And one challenge for buyers and homeowners who want to refinance is they must prove to the lender they have enough income to afford the payments.

Meeting that standard isn't easy, says Carolyn Hastings, a broker associate at J. Rockcliff Realtors in Blackhawk, Calif.

"The banks give them a preapproval in about 30 seconds, but to actually close the deal, they are nit-picking the heck out of them," she says. "If it takes 90, 120 or 180 days to close, they could have lost their job and found another one, but they're underemployed or getting less from their employer. There are so many things that could happen."

With that in mind, here's a look at what it takes to income-qualify for a mortgage today, whether for a purchase or a refinance.

Taxable income is the only kind that counts.

As a general rule, only taxable income can be counted when qualifying for a mortgage, says Julie Miller, a sales manager for Prospect Mortgage Co. in Irvine, Calif. This requirement trips up not only self-employed people but also employees who deduct unreimbursed employee business expenses on IRS Form 2106. Examples include business mileage, parking, travel, meals and entertainment costs.

"If you earn $60,000 a year but you wrote off $5,000 in expenses, meaning you had to spend $5,000 to make $60,000, then your taxable income is only $55,000," Miller says.

Nonsalary sources of income, such as a second job or sideline business, are acceptable if the income is consistent and reported on the borrower's tax return, says Peter Thompson, a senior loan officer at Prospect Mortgage Co. in Naperville, Ill. Social Security benefits, pension payouts, child support and the like can count, too, if the payments are regular.

Seasonal income typically must be annualized to smooth out highs and lows and show a true picture, Thompson says. Examples include construction workers whose hours are dictated by the weather and retail sales clerks whose schedules vary by holiday shopping patterns.

Lenders look backward and forward.

Lenders use a two-year look-back period to evaluate a borrower's income for a refinance or purchase mortgage. But that doesn't mean the borrower must show two years' worth of employment in the same job with the same employer, Thompson says. Instead, any gap in employment needs to be explained, and current income must be consistent and reliable.

"You don't have to be at the job for two years," he says, "but you have to show that what you're working at now is likely to continue and that the income is realistic."

Debt-to-income ratios are conservative.

Lenders use a debt-to-income ratio, or DTI, to figure out whether the borrower can afford the mortgage payment, even if it's for a refinance with a lower payment. Years ago, borrowers could qualify with a DTI as high as 60 percent or even 65 percent. Nowadays, Miller says, most loans require a DTI of no more than 45 percent. FHA loans, insured by the Federal Housing Administration, are a bit more flexible.

"The automated underwriting systems typically want 45 percent or below," Miller says. With "FHA, you can still go to 50 fairly easily."

Forget stated-income loans.

Few borrowers can declare their income without documentation when they refinance or get a purchase loan. Though some lenders still offer stated-income loans, Miller says these are rare and typically targeted to borrowers who have substantial assets and are willing to accept higher interest rates.

"Income is of critical importance," Miller says. "If you want to get the better rates and terms and be able to make the minimal down payment, you have to income-qualify."

One exception is an FHA streamlined refinance loan, which requires a verified income source but not a documented amount or calculated DTI.

In Illinois, Thompson says, stated-income loans are not only off the market but are technically illegal.

Banks enforce strict guidelines.

A strong credit score or hefty down payment relative to the property value might net some flexibility on the DTI but not much wiggle room in terms of income qualification.

That can be especially hard for homeowners who want to refinance to reduce the monthly payment but don't have adequate income for today's guidelines.

"Every time you refinance, there is a new investor," Miller says, "and that investor has to mitigate the risk by making sure there is enough income to make the payment; otherwise, they will let the current investor keep the loan."

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