Fannie Mae, Freddie Mac, FHA, and VA all qualify mortgage borrowers by using their gross income. You would think they would use net income, which is after tax income. Especially since a mortgage payment is paid out of after tax income. But they do use gross income. I am sure if they suddenly shifted the guidelines to using net income to qualify mortgage borrowers, the allowable debt ratios would go up to compensate for using the reduced after tax income.
In the mortgage world non-taxable income will usually be grossed up 125%
What this means is that a mortgage borrower with non-taxable income needs to have that non-taxable income “grossed up”. It gets grossed up to approximately whatever level the income would be if it were being earned as gross income. The rule makers arbitrarily use a 125% gross up figure. This means you’d multiply the non-taxable income by 1.25 to determine the gross income to be used in qualifying the borrower.
Borrowers with $4,000 per month in non-taxable income would have $5,000 per month in “grossed up” income for mortgage underwriting purposes. The calculation would look like this: $4,000 x 1.25 = $5,000.
My client story
I had a client recently who was working with a lender who told them they were only pre-qualified for a mortgage of $450,000. However, I pre-qualified them to over a $550,000 mortgage! We finally figured out the former lender was not grossing up the non-taxed portions of their military income.
Non-taxable income may come from:
•Some portions of military income
•Some portion of Social Security, some Federal government employee retirement income, Railroad Retirement Benefits, and some state government retirement income
•Municipal Bond Interest
•Qualified Annuities
•Child support
•Certain types of disability and public assistance payments
•Other income that is documented as being exempt from Federal income taxes
Conclusion
If you or someone you know has non-taxable income, make sure they know the above information.
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