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How is Bonus, Overtime, and Commission Income Calculated by My Mortgage Lender?

Dani Hernandez Oct 25, 2021
variable income in mortgage process

Variable income is defined as income that can vary from month to month or year to year. Some of the common types of variable income are:

  • Bonuses
  • Overtime
  • Commission
  • 1099 income
  • Part-time jobs
  • Rental income
  • Dividends and interest

Since this type of income isn’t consistent, lenders need to look at your income history and calculate an average.  A few other factors go into the calculation, which we'll cover below. For now, just know that if you plan on using your bonus, overtime, or commission income, expect to have to jump through a few more hoops before being approved for a mortgage.

Here are the rules for variable income; don’t worry, we will explain what these rules mean and how they are applied.

 

Variable Income Rules

All income calculated by an averaging method must be reviewed to assess the borrower’s history of receipt, the payment frequency, and the trending of the income amount being received. Examples of this type of income include:

  • Income from hourly workers with fluctuating hours
  • Income that includes commissions, bonuses, or overtime

History of Receipt

Two or more years of receipt of a particular type of variable income is recommended; however, variable income that has been received for 12 to 24 months may be considered as acceptable income as long as the borrower’s loan application demonstrates that there are positive factors that reasonably offset the shorter income history.

Income Trending

After the monthly year-to-date income amount is calculated, it must be compared to prior years’ earnings.

  • If the trend in the income amount is stable or increasing, the income amount should be averaged.
  • If the trend is declining but has since stabilized, and there is no reason to believe that the borrower will not continue to be employed at the current level, the current lower amount of variable income must be used.
  • If the trend is declining, the income may not be stable. The additional analysis must be conducted to determine if any variable income should be used, but in no instance may it be averaged over the period when the decline occurred.

What does that even mean?!

We’ll use UpEquity as an example. For our loan underwriting, UpEquity will need to verify three amounts of income:

  1. Year-to-date variable income (2021)
  2. Previous year’s variable income (2020)
  3. Second previous year’s variable income (2019)

Let's assume we're halfway through the year, so you have 6 months of 2021 income. To verify these amounts, we’ll ask you to provide the following, in addition to your W2s.

  1. Most recent pay stub
  2. 2020 year-end pay stub
  3. 2019 year-end pay stub

And why do we require this, you may ask? Well, unlike your W2s, your year-end pay stubs provide a breakdown of income types and amounts.

If for whatever reason, you can’t locate your year-end pay stubs, UpEquity can reach out to your employer and request a written verification of employment. It can take a few days or weeks for your employer to reply back with the information we requested, so we try to verify the information using your pay stubs first.

Now, let’s do a quick example of how we calculate your variable income: Let's pretend your most recent pay stub shows earnings through June 30, 2021. 

  • YTD variable income: $6,000 +
  • 2020 variable income: $10,000 +
  • 2019 variable income: $9,500 =

Total income across three years = $25,000

Divide this ($25,000) by the number of months for which you've collected income.

  • 2021 = 6 months +
  • 2020 = 12 months +
  • 2019 = 12 months =

30 months of variable income collected total. So $25,000 divided by 30 = $850.

This means that your qualifying variable income is $850 per month!

For more information on income qualifications during the mortgage process, check out another article addressing one of the most frequently asked questions about income: Can I use future rental income to qualify for a mortgage?