New Year, New Loan Amount
The new calendar year could mean that you qualify for a new loan amount. This can be great news if you are making more money, but can also be to your detriment if you've seen a decrease this past year. For those of you who are self-employed, I highly suggest making your accountant aware of your home ownership intentions and working with your loan officer prior to filing.
If Your Income Increases
Congratulations! As you know, loan officers (LO) typically look at your last two years of tax returns when calculating how much you can afford when approving you for a mortgage. As always, there are exceptions to this rule based on the product (loan) and LO, but I am speaking in generality.
Let’s say you made $100k two years ago and you got a raise so last year you made $120k. That is an increase of $20k. However, when calculating your current income because you haven’t made $120k for two consecutive years, the bank will usually split the difference and will use $110k as your income. Similarly, if you got a $50,000 raise from $100k to $150k they will use $125,000 as your income.
If Your Income Decreases
Life happens, and sometimes people have financial setbacks that are temporary (and at times due to positive life events) which don’t impact the long-term goal of homeownership but at the same time, don’t look great on paper. Some common examples I have come across are new parents who took maternity/paternity/ family leave, employees who temporarily gave up a stipend due to a packed schedule but will resume it in the new year (ex: a teacher who didn’t coach last year because she was finishing her masters which will result in a pay raise), an extended illness where a person was either on disability or wasn’t working their typical amount of overtime but will resume their regular hours in the new year, or a loss of a job where the person was then hired to a new position where they are making more money.
Unlike when you get a pay raise and the bank splits the difference when your income decreases they use the lower salary. If you made $120,000 two years ago and made $100,000 last year they are typically (remember there are always exceptions) going to calculate your current income at $100,000.
Let’s say you had one of those financial setbacks on paper but what’s in writing doesn’t reflect your upcoming year. For example, your income went from $120,000 down to $100,000 last year, but this year with your new raise you will be making $150,000 so you are confident you will be able to make the payments calculated off your income at $120,000, great! You don’t have to file your taxes until April 18th this year, so let’s find you a house and get you under contract and get a commitment from the bank before that date.
If you are planning on purchasing in the fall after the April 18th deadline give your loan officer a call. Explain the situation and see if they have any suggestions for you and your accountant so you can plan for the upcoming year.
If You are Self Employed
Nobody likes to pay taxes and accountants get paid to save their clients money. However, sometimes accountants are a little too good at their jobs (after all even Jeff Bezos claimed a loss on his taxes in 2011 while he was reportedly worth $18 billion). The amount of money that mortgage companies can lend you is tied to the amount you claim on your income taxes.
If you are living a $150,000 lifestyle but only claiming $50,000 on your taxes, your loan officer has to go off the number you reported to the government, so they are going to calculate your mortgage off of a $50,000 salary.
Yes, there are bank statement programs. These loans look at what is in your bank account. If you claim $50,000 but have the bank account of somebody making $150,000 they will give you a mortgage of somebody with a $150,000 salary but you are a significantly bigger risk (because remember you technically only claimed $50k) so you are going to pay a MUCH HIGHER interest rate.
If you don’t want to pay the higher interest rate for 30 years (and nobody really wants to do that) you can explain to your accountant that you are looking to purchase a home within the year. Have your accountant do a draft of your taxes and send that draft to your loan officer to look over. It usually makes sense to pay a little more in taxes for one year and save on the interest for the next 30.