In a perfect world, lenders would like it if every borrower had a standard salary that is predictable and stable. Unfortunately, that is not the case today. In fact, a majority of people have an irregular income since so many people are self-employed or work on commission. People have had to get creative in their income producing methods ever since the economy spiraled downward. The good news is, though, that you can still qualify for a mortgage with irregular income as long as you know what you need to do.
Prove the Stability of the Income
The hardest thing to prove when you have income that is irregular is its stability. Lenders want to see that you have a history of receiving this income as well as that it has the potential to continue for the near future. With salaried income this is easy to track, but irregular income might be a little tougher to prove. Following are a few ways to prove it, though:
- Tax returns – Most lenders want to see the last two years of your tax returns, but some might accept one year if you are newly self-employed
- Bank statements – Some lenders will accept your bank statements for the last twelve months if the receipt of your income is easily tracked
The more stable your income is, whether that means from month to month on your bank statements or a steady stream of income on your tax returns, the more likely it is that you will get approved.
Annualizing Irregular Income
The hardest part of dealing with irregular income is annualizing the income. Unlike a steady salary, you do not have a set amount of money you make each week or even month. You might have ups and downs based on the seasons or other factors that affect your business. This is the reason that lenders need to annualize your income. This means they take an average of your income over a long period of time. This used to mean a 2-year average, but in some cases, lenders can use a 12-month average.
Let’s look at an example. You own a landscaping company that is obviously busier in the summer months than the winter months. During the summer months you make a great deal of money, which would make your debt ratio very low and your ability to get approved very high. During the winter months, however, your income is much lower and your debt ratio is much higher. In order to make up for the difference between the two periods, the lender will take a 12 or 24-month average of your income. This average will take into account the highs and lows, giving you an annual average. This number is then what is used to figure out your eligibility for a loan.
Have Compensating Factors
Perhaps one of the most important things you can do if you have irregular income is to have compensating factors. This means positive factors that make up for the fact that you have income that fluctuates on a regular basis. The following items are typically used as a compensating factor:
- Reserves that can be used in the place of your income; the more months of reserves you have on hand, the less risky your loan becomes
- Low debt ratios are very important. The lower your debt ratio is, the better off your chances of getting approved become. This means your debt ratio with the annualized income, so paying down as much debt as you can will really help.
- Good credit should never be overlooked. A high credit score is not always the determining factor in your eligibility, but it will certainly help to sway a lender’s mind if they are on the fence regarding the instability of your income.
Qualifying for a mortgage with irregular income is no longer impossible; it just requires a little creativity. You cannot just assume that you can provide the lender with standard income documents and get approved. The lender will need more documents that will help them to understand the full impact of giving you a loan. The more you cooperate with the lender and the more you plan ahead for the loan application process, the more successful you will be in obtaining a loan as a self-employed or commissioned borrower.