Over the years I’ve come across many people who consider overtime income to be a permanent source of income. Many people who apply for loans including credit cards, car loans and mortgages, apply using overtime income as effective income enabling them to qualify for a larger loan.
For example: Recently I had an applicant that applied for a mortgage loan over the Internet. In answering the question about his yearly income, his reply was $46,000 per year. After talking to the borrower and probing into his income I learned that his actual income was $17.31 per hour, which totaled $36,000 per year. The other $10,000 was based on overtime income.
I highly recommend that NO ONE should base his or her budget off of overtime income. Doing so can have a devastating affect on your finances. At any given time your employer can eliminate your ability to work overtime or life circumstances can force you to work less hours. Case and point: I talked to lady a couple of weeks ago that was looking to buy a home. She was a Nurses Assistant who had been working for her company for 15 years. I asked her how much money she made. She immediately responded $65,000. My next question was did she receive overtime or bonuses. She replied that it was already factored into the $65,000. After probing into her income, I learned that she made $13.00 per hour, which totaled $27,000 per year. The remaining $38,000 came from overtime. She had been working this type of overtime for quite some time. Naturally she began to look at it as if she will continue to make $65,000 plus for years to come. Her budget was based on the budget of a person who was making $65,000 per year. The type of house she was looking for was based on a person who was making $65,000 per year.
Earlier in the year this lady had some type of medical condition that forced her out of work for a couple of months. When she returned to work, her doctors placed her on light duty and she can only work 35 hours per week. As you can imagine, this had an impact on her finances. But for some reason she still had the mindset that she could afford a higher priced home. She assured me that in no time she would be back to working 70-80 hours per week and that everything will be ok. I explained to her how Mortgage Lenders evaluate overtime income.
How do Mortgage Lenders evaluate overtime income?
When evaluating income, Mortgage Lenders look for stability and continuity of income. Overtime income can be used if the employer verifies that the overtime income has been received for the past two years and that in all probability the overtime income will continue. In verifying overtime income, lenders average the overtime income over the last two years. They than look at the most recent paystub to verify regular receipt of the overtime income and to verify if the current overtime is consistent with the average overtime income the previous two years. Annual overtime earnings that are level or increasing from one year to the next are acceptable. However, if the trend for the overtime earnings shows a decline, they will not be considered as stable.
In the Nurses Assistant case, she was able to prove previous overtime income. Due to her medical situation that forced her to cut down on her hours, her recent paystubs would not justify her continually making the type of money she had made in the past. As a result, I could not use the overtime income as effective income. I would be able to document the income and use it as a compensating factor—meaning, if she didn’t qualify based on rigid income guidelines, she’d be considered for an exception because of a compensating factor. Banks have similar guidelines for other loan types including car loans, credit cards and student loans.
Overtime income is short-term. Mortgage obligation is long-term. It will be foolhardy to think that your overtime income will continue for the duration of a mortgage obligation. I recommended that she look in the price range based on her actual income because overtime income isn’t guaranteed. I have not heard from her since. I hope that everything works out for her.
In closing, don’t bank on overtime income. Save the money instead and use it to purchase expensive items without accumulating debt.
(Mortgage and Money Coach Damon Carr is owner of ACE Financial. He can be reached at 412-856-1183.)