Determine your income and make a budget

How do I make a budget?

The first step in the process is to determine your income. Find your tax returns for the last three years - five would be even better. You are almost certainly going to need at least two years' returns for your lender anyway. Recent paycheck stubs will also be needed, along with W-2 statements for the past few years showing your yearly income. If you are salaried, look at your gross income and the changes over the years. This should show you (and your lender) if your income steadily increased, decreased, or was relatively stable. Stable means that it kept up with inflation. If there was no increase or an increase less than inflation over the years, it will be considered to have decreased.

What if I am paid on commission?

If your income is not salaried, you have to take extra steps. Commissions are not considered as reliable as salary. This is because commissions generally correspond directly to how hard you work, rather than if you show up for work and do an adequate job. Taking a couple of weeks off due to illness, for example, could affect commission earnings much more than salary. Loss of one large account is another example of a possible problem. If your tax returns show that your commission earnings have increased over the years, you may be in even better shape than a salaried person. Many types of commission earnings depend on residual earnings. If you sell insurance, you may get a commission for every renewal, or even every payment made on the policy.

Your income this year would include not just the policies that you sold this year, but the residuals on the ones you sold last year and the year before. Examine your income from this perspective. Also, look at the negative aspect. Will a substantial amount be going down because some of your residuals will be ending shortly? Your lender may miss this, but you should be prepared for the income reduction.

The second part of your examination should cover the times during the year your commissions are earned. If you sell wrapping paper, you might make 75% of your money in the last quarter of the year. If you apply for a mortgage loan in August, your income for the year will show a substantial decrease over prior years. Your lender will probably not go to the trouble to figure out why. If this situation applies to you, figure out the percentage you earn late in the year and write a short letter detailing this.

Example: You earn 75% of your income in the second half of the year. Your tax return for last year shows that you earned US Dollars 40,000. You earned US Dollars 10,000 from January through June, and US Dollars 30,000 from July through December. You apply for a loan at the end of June. Your yearly income shows that you have earned US Dollars 15,000 through June. Your lender will use this as half your yearly income and project that you will earn US Dollars 30,000 this year, a substantial decrease over last year. Actually, your projected income based on how you have earned your money in the past is US Dollars 60,000, a substantial increase. If you point this out in writing and attach it to your application, it should be considered. If you do not and your lender does not consider it, you will be rejected for insufficient income. Get a letter from your employer stating that what you are writing is true.

The opposite may also be true. If you sell gardening supplies, you may sell very little in the latter part of the year. A lender could look at your year-to-date income in July and conclude that you are going to make a lot more money this year than in the past. You should know the true picture so you do not get approved for a mortgage that you cannot afford.

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