How Lenders Analyze Income

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Different lenders interpret income in different ways.  But there are some general parameters that lenders tend to adhere to and that you should know about before your refinance or buy a property.  We'll discuss both people who are self-employed and employed by others.


If you are self-employed, you must have been in business for at least two full years. The lender will require your two most recent full federal tax returns, then calculate your income by averaging the two years.

Self-employed people include:

• Sole proprietors (they must provide Schedule C on federal tax form 1040).

• Partners (income is generally reflected on Schedule E and in a KI).

• People with a 20 percent or more interest in a corporation (they must provide W2s, plus form 1040, plus corporate returns on form 1120).

• Salespeople who derive their sole income from commissions, even if they receive W2s.

When analyzing a Schedule C, lenders don't use the figure for gross revenues received but look at net after expenses.  However, certain items, such as a home office expense or depreciation can be added back in.  Although an income and expense statement for the current year is required, it's given little weight, particularly if it shows a large difference between the income and expense statement and the previous year's tax return.


Income for people who are not self-employed is usually easier to analyze. You normally do not need a two-year history on the job. In fact, it's possible that someone just out of school and starting a new job can get full credit for his or starting salary even before the first day of work, but most lenders prefer that a borrower has been employed long enough to generate at least one pay stub. Bonuses and overtime Ronica Lee are typically averaged over a two-year period, so you would need to have been on the job for some time to qualify for this income.

Investment Income

Items in this category generally include rental income, interest and dividends.

For rental income, lenders calculate 75 percent of the gross income less PITI (principal, interest, taxes and insurance). A few lenders use a method where, on owner-occupied property, income from the rental unites) is subtracted directly from PITI. This method results in dramatically better deb¬t-to-income ratios.

Other investment income, such as interest and dividends, are calculated from 1040s by averaging the previous two years, plus documenting that the borrower still holds these assets.

Debt-to-Income Ratio

After income is determined, it's evaluated on the basis of a debt-to-income ratio that factors in what you owe. This includes housing expenses (mortgage payments plus property taxes and insurance) and all other debt (such as car payments, student loans and credit cards) as a percentage of pretax income. It's interesting to note that allowable debt-to-income ratios are much higher than when I first came into the business. Then the usual standard was 38 percent; now 45 percent is common and there are some cases where allowable ratios surpass 50 percent.