When consumers apply for a mortgage, the lender provides them with a checklist of documents needed to support their application. Most banks require payslips for the last 30 days before submitting an application. Many people do not have payslips because of retirement or because they work for themselves. Banks accept applications from people who do not have payslips by using other forms of income verification.
Types of Income Verification
Banks require social security recipients to provide their most recent annual award letters when applying for loans. States and company pension plans normally issue annual benefits letters that detail the amount of a retiree's income, and banks also require copies of these. The self-employed must provide the bank with complete business and personal tax returns. Some banks accept income derived from rental property if the borrower can produce a valid lease agreement. Anyone with a W2 must provide it to the lender.
Banks require two years of tax returns from the self-employed and a business profit-and-loss-statement for the current year. To verify retirement income letters, banks require bank statements for the last 60 days that show the payments in their accounts. On an exception basis, to help underwrite loans for people with marginal income, some banks accept two years of brokerage statements to substantiate investment income. Most lenders require evidence of at least one year of steady payments before accepting income from rental properties.
Banks use income verification to establish the debt-to-income (DTI) ratios of loan applicants. Banks sell most mortgages to government-backed entities Fannie Mae and Freddie Mac. These entities bundle mortgages together and divide the resulting packages into bonds which they sell on the secondary investment market. In order to minimise the risks to investors, Freddie Mac and Fannie Mae impose DTI guidelines aimed at ensuring homeowners can reasonably afford their mortgages. Banks use similar guidelines for portfolio loans that they retain.
Loans for new homebuyers insured bye the Federal Housing Administration (FHA) allow a maximum DTI of 41 per cent. That means that no more than 41 per cent of an applicant's gross monthly income can go towards the mortgage, car loans, credit card debt or any other type of credit related debt. Additionally FHA imposes a housing ratio of 29 per cent, which limits the amount of the actual mortgage payment. Typically housing ratios range between 25 and 31 per cent with DTI ratios between 38 and 42 per cent.
Banks require self-employed people to have two years of steady income that meets DTI requirements and for the business to have strong cash-flows. Many small business owners struggle to qualify for loans because tax write-offs greatly reduce their taxable income.
People just starting work with no prior employment history who do have 30 days of pay stubs often qualify for mortgages more easily than the self-employed because the banks use their pay-stubs as the sole basis of the DTI qualification.