Overtime is in the news a lot lately. So it seems like a good time to discuss overtime and how it affects buying a home. A recent CNN Money article by Jeanne Sahadi called “New rule expands overtime pay to millions of workers” explains the big rule changes. These changes take place December 1, 2016 and can affect employers and employees.
Overtime can be looked at as a burden to some as it takes away from their free time. Others see an earning opportunity. For buying a home and getting a mortgage, this extra income may solidify the approval. So let’s explain how lenders look at overtime and how you can use it to qualify for the house you want. Plus you will know how to prepare before the application for quickest prequalification.
How is Overtime Calculated on a Mortgage Loan?
To count overtime, there must be enough history and it is likely to continue for the near future. To count as income, lenders must first document the average overtime over a period. The required period depends on loan type, trend, and consistency of overtime. Additionally, it is determined by overall make-up of the file and the actual pre-approval itself.
Step 1 of Income Calculation: Obtaining pay breakdown
Paystubs help calculate the breakdown of base and overtime pay for the current year. But for previous years of overtime, w2’s and tax returns do not break down the income. So lenders must order a verification of employment form which is completed by the employer. There are boxes to complete that break down the income so we can come up with an accurate income calculation. There are also boxes to complete which state if the overtime is “likely to continue”. This is obviously important.
Step 2 of Income Calculation: Calculating the base income
Before calculating the total income, a lender must determine the base income. The base is normally not averaged over time, and the lender may use the current hourly rate. So even if an employee made $15 per hour for the last 2 years and just got a raise to $20 per hour, we can use $20. So as long as the employee has been working 40 hours a week consistently, the current hourly rate times 40 hours is used for the base calculation.
Step 3 of Income Calculation: Calculating the overtime income
2 year average of overtime: This is the most common way of calculating overtime income for mortgage lending. First add total extra time over the last 24 months. Next, divide the total by 24 to come up with the monthly amount. In order to average this portion of income, it must be the same amount or increasing in the most recent year in comparison to the prior year. For example, an employee earned $2000 of overtime in 2014 and $4000 in 2015. See how the income is increasing? Therefore, it could be averaged.
1 year average of overtime: Sometimes loan pre-approvals only require 12 months of income documentation. If that is the case, then a lender would be able to average the last 12 months of overtime to add to the base income.
Step 4: Figuring the Mortgage Qualification
At this point, we can complete the process of figuring the mortgage qualification. So we use our knowledge of VA, USDA, FHA, Conventional, and Jumbo guidelines. Finally, we figure the mortgage and purchase price a buyer can qualify.
Exceptions to rules:
Sometimes it is possible to vary from the cut and dry rules. So occasionally it makes sense yet falls within guidelines. For instance, even government loans like VA could allow us to average overtime received for only 20 months. Even though we may need to average over 24 months, it beats not counting it.
What to provide at application:
For a quicker and more accurate prequalification, it would help to have the correct documentation in hand at application. By providing complete documentation up-front, your chances of closing quickly increase. Ideas for you to have the most successful meeting with your loan officer would be to bring the following:
- Most recent 30 days of paystubs with year to date pay breakdown
- Last 2 years of w2’s and tax returns
- If paid overtime, use one of these ways to provide your income breakdown
- Last paystub for each of the previous two years with YTD pay breakdown
- Printout from your employer stating income breakdown for previous years
- If neither is readily available, at least get a verbal breakdown from your employer
Look here for a more complete list to have ready for us at application. We hope that this has helped educate you on how overtime income could help you qualify for your new home. The most important thing to remember is, don’t try to figure it out yourself! Gather your documentation and apply with one of our expert loan officers. Then we will use our tools to help you qualify for your new mortgage.
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