Things to consider before stating your income

Stated income on mortgage applications is getting a lot of attention these days, and for good reason. Stated income loans, also called liar loans, let borrowers (and loan officers) put whatever they want within "reason" for the income used to qualify for the loan program. The underwriter looks at the income on the application and then checks a site such as www.salary.com to confirm the salary range. They then calculate the borrower’s debt to income ratio (DTI) off of this income.

I wanted to look at this issue from both the consumer perspective and the mortgage professional’s point of view. We’ll focus on why it is bad (for the most part) from a borrower’s stand point in this post.

As a consumer:

Using stated income always sounds like a good idea, because it lets you qualify for a loan that you otherwise would not be able to get. While it sounds exciting to buy the house with the extra bedroom or get an additional $20,000 out of your house with a refinance – it is almost never a good idea.

The interest rate on these loans is higher than fully documented loans, so if you combine the larger loan amount that you now qualify for plus the additional interest costs from the higher rate you end up with significantly higher monthly payments. You look at the higher mortgage payment and start thinking "We’ll just eat out less" or other, irrational thoughts to justify affording your mortgage just to enjoy the larger loan or bigger house. Don’t end up house-poor. Figure out how much mortgage you can really afford.

To figure out how much you can afford determine how much of your income is going to the house payment. Take what your mortgage payment will be and subtract it from your monthly take home pay. This will give you how much actual cash you will have left over for other expenses. This is different than how the bank does it. The bank is going to look at your GROSS income which is before taxes are taken out and then calculate what percentage the new mortgage payment will be out of that income. You want to look at after-tax income so you can see how much real cash you have left over each month.

This left over amount is what you have to pay for EVERYTHING else.

A general rule that I go by: If you’re mortgage payment is equal to or more than one of your paychecks (after taxes) you are going to feel especially pinched by your housing expense. When you are pinched by your housing expense you put yourself at greater risk of default because any small change in your income or loan term will be the proverbial "straw that breaks the camel’s back."

You want some cushion so that if your loan terms change (interest rate adjusts, etc.) or if you lose your job, have to take a salary cut, get laid off, etc. you have some cushion to afford your mortgage payment for a few months while getting back on your feet. If you are stating your income you are leaving yourself with out any cushion and when the larger monthly payment rolls around you’ll have a much harder time meeting it and your other obligations.

Bottom line: avoid the temptation to get the bigger loan by stating your income. If a loan officer or Realtor tries to entice you in to more than you can afford by inflating your income through a stated income loan turn down the offer and go elsewhere. Remember it is up to you to choose the right mortgage for you and your family. Just because someone can qualify you for the payment doesn’t mean you can afford it.

NOTE: There are a couple of reasons why you would use stated income and those have to do with situations where you are self-employed or have non-traditional income streams. In those cases when you are making the money but have a difficult time documenting it, stated income may make sense.

Remember, stating your income higher than it actually is is MORTGAGE FRAUD. Fraud is a felony. Don’t be a felon.