What Income Do Banks Look at When Buying A House?

Buying a house is an exciting milestone in life. However, it also involves a lot of planning and budgeting. One of the most important factors lenders consider when you apply for a mortgage is your income. But there is no set minimum income requirement to qualify for a home loan. Rather, banks look at various aspects of your finances to determine if you can comfortably afford the monthly mortgage payments. In this comprehensive guide we will look at what income banks consider when you apply for a mortgage to buy a house.

Overview of Lender Income Requirements

When you apply for a mortgage, lenders want to confirm you have a stable source of income to repay the loan. Here are some key points on income requirements when seeking mortgage approval

• Lenders look at your gross monthly income, meaning income before taxes and other deductions. Your total household income is considered.

• There is no universal minimum income to qualify. Income requirements vary by lender, loan type, location, home price, assets, credit score and other factors.

• While amount of income matters, lenders closely evaluate your debt-to-income ratio, savings, employment history and credit profile.

• Both salaried and self-employed home buyers must provide income documentation like pay stubs, W-2s and tax returns.

• Income from bonuses, commissions, side jobs, retirement accounts and investments may also be considered.

• Guidelines on using rental income, child support, disability payments and other unconventional income sources can be program-specific.

• Loan qualifying income is documented and verified by underwriters to evaluate if you can manage the mortgage long-term.

Gross Monthly Income Calculation

Lenders look at your gross monthly income, not your take home pay, when reviewing your home loan application. Gross income includes:

• Wages and salaries from full-time and part-time jobs

• Self-employment or freelance income

• Social Security retirement benefits

• Pension disbursements

• Dividends and interest

• Child support and alimony

• Military pay and veterans benefits

• Disability income

• Bonuses and overtime pay

• Commissions and tips

Income from all adult applicants is combined to determine total household income. Be sure to disclose all your income sources when applying for a mortgage. Underreporting income could derail the approval process once discrepancies surface during verification.

Debt-to-Income Ratio Assessment

While your income level influences loan qualification, lenders pay equal attention to your debt-to-income (DTI) ratio. DTI compares your total monthly debt payments to your gross monthly income.

Monthly debts factored into DTI include:

• Housing costs (rent/mortgage, property taxes, insurance, HOA fees)

• Credit card minimum payments

• Auto, personal and student loan payments

• Child support and alimony

• Other debts with a monthly payment

To calculate DTI:

Total Monthly Debt Payments / Gross Monthly Income = DTI Ratio

For example, if your income is $6,000 per month and debt payments total $1,500, your DTI is 25% ($1,500/$6,000). Many lenders prefer a DTI of 43% or less for conventional loans. DTI limits can be lower for government-backed FHA, VA and USDA loans.

The lower your DTI, the better because you have more available income to cover the mortgage payment. A high DTI signals you may be overextended. Even with a large income, a DTI over 45% could make approval challenging.

Income Documentation Required

All income disclosed on a mortgage application must be verified and documented. Employees typically provide pay stubs covering the last 30 days along with W-2s for the last two years. If you have a second job or side gig, expect to also furnish paystubs and 1099s from those income sources.

Self-employed borrowers need:

• Two years of business and personal tax returns

• 1099 forms

• Year-to-date profit and loss statement

Other income proofs may include:

• Two years of investment account statements

• Award letters confirming pension or Social Security amount

• Court orders and bank statements for child support/alimony

• Lease agreements and rent payment history for rental income

Have all your documentation ready before starting the loan process. Any gaps will delay approval. Underwriters review income papers line-by-line to verify your history of steady earnings.

Income Eligibility Across Loan Types

Conforming conventional loans backed by Fannie Mae and Freddie Mac tend to have the most flexible income requirements. These mainstream mortgages fund up to $726,200 for a single-family home in 2023. Government-insured FHA, VA and USDA loans can have tighter income limits.

FHA Loans

FHA allows non-traditional credit histories and lower credit scores starting at 580. But income minimums apply. Your total gross income across all years documented must average above the FHA floor for the county where you want to buy. The 2023 FHA floor ranges from around $37,000 to $60,000 depending on location.

VA Loans

There are no set income brackets for VA loans. However, you must satisfy the VA residual income test. This confirms you have adequate income left over every month after paying major debts and the new mortgage. VA underwriting uses a sliding scale based on family size.

USDA Loans

Along with home location limits, USDA mortgages have income caps based on the area median household income. In 2022, income cannot exceed $114,600 in most counties to receive a USDA-guaranteed home loan. Higher limits up to 150% of median income apply in some pricier real estate markets.

Jumbo Loans

Jumbo mortgages exceed the conforming limit up to $3 million. Lenders often want higher income and larger down payments for these big balance loans. Consider an annual income of around $200,000 the baseline to qualify for a jumbo mortgage.

Using Retirement and Investment Income

Retirement income and investment earnings can supplement your employment income. But lenders apply some limits:

• 401(k) and IRA funds: 70% of the vested account balance can count toward your qualifying income.

• Pension income: 100% if you’re already drawing payments. Future pension income may be discounted.

• Social Security: 100% if already collecting benefits. Estimate 85% of future benefits if not yet receiving payments.

• Stocks and bonds: Income counts at 70-80% of two-year average. Total portfolio cannot be over 50% invested in one stock.

• Rental income: Typically just 75% of monthly rents less expenses and vacancies. Two years of tax returns showing net rental income are required.

Tap retirement funds conservatively when budgeting to buy a house. Lenders prefer no more than 50% of your total qualifying income coming from assets and investments.

Special Rules for Self-Employment

If you’re self-employed or own a business, mortgage qualification involves a few extra steps. You’ll need a two-year history of stable earnings. Lenders average your net income over two years if it’s rising or use the lower amount if income is declining.

You should be prepared to provide:

• Federal business and personal tax returns for last two years

• Corporate returns if incorporated

• 1099 forms and schedule K-1s if a partnership

• Year-to-date profit and loss statement

• Business license and entity documents

Self-employed individuals sometimes use generous deductions to lower tax bills. But mortgage lenders add expenses like depreciation back when computing your eligible income.

Other Specialized Income Sources

Mortgages allow customized underwriting for borrowers who don’t have a rigid W-2 pay structure. Income like child support, disability, trust funds and even seasonal unemployment may count if properly documented.

Types of non-traditional income sources lenders may evaluate:

• Child support – Consistent receipt for 3+ years expected

• Housing allowances – For military members or clergy

• Trust fund disbursements – Trustee letter and copies of statements required

• Lottery winnings – Verified regular payments over several years

• Unemployment – For seasonal workers during off months

• Worker’s compensation – If long-term benefit confirmed

• Temporary Assistance for Needy Families (TANF)

• Taxable gifts – From family member with letter stating gifts will continue

In these cases, underwriters scrutinize income closely and set high eligibility standards regarding stability and continuity.

Buying a Home on a Tight Budget

Low down payment programs like FHA and VA help first-time buyers and those with modest incomes break into homeownership.

Strategies to buy with limited funds:

• Lower expectations: Consider fixer-uppers, smaller homes, and less popular locations.

• Include roommates: Rental income from roommates can help you qualify for a pricier property.

• Use gifts: Family gifts can fund your down payment with the right documentation.

• Seek grants: State and local groups offer down payment assistance grants in many areas.

• Lease-to-own: Seller financing deals where you rent first and buy later.

• Special programs: Some nonprofits and employers offer affordable housing schemes.

With the right approach, homeownership may be more attainable even on a tight income.

Key Takeaways

When reviewing income for a mortgage, lenders evaluate:

• Gross monthly income from all documented sources

• Job history and income stability

• Debt-to-income ratio benchmarked to industry standards

• Sufficient income reserves after paying the new mortgage

There is no universal minimum income level or magic salary number that guarantees home loan approval. But in general, the more consistent income you can verify, the larger home loan amount you can qualify for.

Work on building your savings and credit score in advance. Then shop lenders to find a mortgage program suited to your unique financial situation. With prudent planning, homeownership can be achievable even on a modest middle-class income.