Why Qualifying Income Matters
Like we discussed in our Guide To Buying a Home, your income influences how much mortgage you can get and would be determined by your mortgage representative during your pre-approval. In this article we show you how it’s determined so you can plan ahead to see what you need.
How To Calculate Your Qualifying Income
As you go through each source to determine your qualifying income, we’d encourage you to run our Qualifier Tool in parallel so you can get an estimate for your maximum purchase price. You should try to minimize the number of sources you need to rely on to qualify. To illustrate, let’s say that you have the following income details:
- Annual Base Salary: $60,000 (Source 1)
- Annual Bonus: $5,000 (Source 2)
- Down Payment: $50,000
Using our Qualifier Tool, if we use just your base salary you qualify for up to a $332,000 property price. If your budget was to spend between $250,000-$300,000 on a home, you comfortably qualify and don’t need to include your bonus income (Source 2). The objective isn’t to maximize what you qualify for, but rather to qualify for what you need with the least amount of uncertainty. Each additional source of revenue comes with more documentation you need to provide and could limit which lenders take your deal (which can then impacts how low your mortgage rate is).
Source 1: Base Salary
This is your annual gross income and is viewed as “guaranteed” income. How your job letter is worded will determine if lenders accept it as such, so the language your employer uses when drafting it is important. Typically, guaranteed hours would be worded in a manner similar to these examples below:
“Is a full-time employee working 37.5 hours per week and receiving a base salary of $50,000 per year”
“Is a part-time employee working 20 hours per week and receiving a base salary of $20,000 per year”
“Is entitled to a minimum of 25 hours per week at an hourly rate of $20 per hour”
If the job letter can’t confirm you have guaranteed hours or states you’re on contract, then unfortunately you don’t have a base salary for Source 1.
The income your job letter states will also need to be supported by your paystub. For example, if your job letter states your salary is $52,000 per year and you are paid bi-weekly, then your paystub should show $2,000 gross pay ($2,000 x 26 payments in a year = $52,000). If you were just given a raise, you can use your new income if your job letter reflects your new salary.
Things to watch out for:
- Probation: If you aren’t past your probationary period before your closing date, you may not be able to use your income.
- Parental Leave: If you expect to be on parental leave before your closing date, this may impact your qualifying income. Every lender has a different policy, but typically you can still use 60-100% of your pre-parental leave income provided that you plan on returning to work within 12-16 months (your job letter would need to confirm this).
- Working Abroad: Your employer doesn’t need to be Canadian, but if you are not living in Canada it can affect your ability to get a mortgage. Your digital nomad lifestyle may be the envy of all your Instagram followers, but your lenders won’t be as enthusiastic!
Source 2: Variable Income
Many people will earn income above the minimum they are guaranteed (bonuses, overtime, etc.), which can be used as qualifying income provided it is consistent and meets the guidelines. Typically, lenders will use the lesser of the 2 year average or the most current year for the variable income. For example, if you were paid a $5,000 bonus in 2018 and a $4,000 bonus in 2017 from the same employer and you’re applying for a mortgage in 2019 then you can use $4,500 in bonus income. You will have to provide year-end paystubs to substantiate the bonus payment.
Things to watch out for:
- Payment Dates: Extra income only counts for the year it was paid. So if your employer completes your 2018 performance review December 2018 and pays you your bonus January 2019, that bonus is income received in 2019 and can’t be used towards your 2018 qualifying income. You could use it the following year as part of your 2019 income though.
- Switching Jobs: For bonuses, lenders will typically only allow for bonus income if it was received in the past 2 tax years by the same employer. If you were paid a bonus for the past 6 years every year at your employer, but then quit your job 6 months ago to join another company you can’t use the bonus income from your previous employer or the future bonus income you could receive with your new employer until you have received a bonus from your current employer for at least 2 tax years.
Source 3: Other Sources of Income
Other than your employer, you could be receiving income from a variety of places such as:
- Pension (including CPP or OAS)
- Child support or alimony
- EI or disability income
- Property rental income
- Self-employment income
- Investment income
These are just a few examples, but typically alternate forms of income will be evaluated similarly to variable income. Note that for it to be on your NOA, you need to have included it in your tax return. Unless you’re applying to an alternative lender, income that is not reported in your taxes (ex: tips) can not be used as qualifying income.
Adding It All Up
Typically, your mortgage representative will need the following documents from you to determine your qualifying income:
- A job letter
- Your latest paystub
- Your 2 most recent T4’s and year-end paystubs (if you’re using variable income from Source 2)
- If you’re using any Source 3 income, each will have their own additional documentation requirements.
As you go through each source with your mortgage representative, you then just add up all three and voilà; you have you qualifying income! The vast majority of people will only need to worry about Source 1 and we realize that a lot of these rules reflect archaic underwriting policies that don’t reflect today’s work environment, but it’s unfortunately the rules we have to play by (today).
One last thing we want to emphasize is that your qualifying income is used by lenders to assess you before your closing date. So if you decide to switch jobs, work from Thailand, have a baby or sell all your investments after you buy your home there’s really nothing stopping you as they aren’t monitoring you afterwards. But in the future, if you want to switch lenders or buy another property you will be re-assessed in the same manner so make sure to plan accordingly. While getting pre-approved, mention any potential life changes to your mortgage representative so they can advise you if it will affect your mortgage options going forward.