How to Gross Up Nontaxable Income for a Mortgage Approval

Income. We all want it, and it comes in many forms: salary, hourly, self-employed, child support, alimony, rental income, retirement, and more. Additionally, each of these breaks down into subcategories. Check the IRS website, and you will see what seems like an endless list of income types. There’s one income group that creates advantages and sometimes confusion: Nontaxable income.

What is Nontaxable Income?

It is a form of income paid to an individual where the gross income equals the net. The amount received is not taxed at the federal or the state level. Many people receive one of these tax-exempt incomes. In addition to no taxation, there is a little-known advantage when it comes to qualifying for a mortgage loan to purchase, renovate, or refinance a home.

Nontaxable Income Types

Certain income types are never subject to income taxes, yet some depend on the scenario. For instance, social security is often a type of nontaxable income. Although at a certain total income level, it becomes taxable. Below is a list of common nontaxable forms of income:

• Disability insurance payments
• Life insurance payouts
• Tax-exempt interest
• Housing allowance
• Auto allowance
• Railroad retirement income
• Military combat pay – some LES income is nontaxable
• Foster care income
• Child support

When it comes to mortgage qualification, home loan programs and lenders care about income history and the likelihood of continuance. Lenders must ensure a borrower’s ability to repay. If a particular type of income will end soon, it should not count toward qualification. However, there are protected classes on this list. One example includes a borrower’s disability income. Lenders may not require proof of disability continuance through a doctor’s note. Conversely, certain payouts or child support have a termination date. These would be verified.

There must be sufficient history to count certain forms of nontaxable income. Examples include foster care income, auto allowance, or pastoral housing allowance. In the end, lenders must first determine if the income type is allowed. If the income is acceptable, then comes a nontaxable income bonus: Grossing up income!

How to Gross Up Income

So, if a borrower’s income is allowed and is considered nontaxable, home loan programs allow a higher amount for qualification. That’s right! Lenders may use a higher amount than the actual nontaxable income amount. This practice is known as grossing up income, and it can significantly improve the chance of loan approval. Additionally, it is allowed for all major agency loan products included under VA, USDA, FHA, plus Fannie Mae and Freddie Mac conventional loans.

The income grossing up process involves multiplying the tax-exempt income times a percentage. 15% or 25% are the industry standard allowed gross up percentages. For easy numbers, here is an example. Assume a $1,000 nontaxable income and a gross up percentage of 25%, which is $250. Next, add the income plus the calculated grossed up income together, which is $1,250. Then, the total grossed up income is used to qualify the borrower.

Gross Up Income Calculator

As mentioned, not all loan programs use the same percentage to gross up income.

FHA Loan

FHA loans allow nontaxable income to be grossed up 15%.

USDA Loan

USDA loans allow nontaxable income to be grossed up 25%.

Conforming Loan

Conforming loans allow this tax-exempt income to be grossed up 25%

VA Loan

Recently, VA clarified their stance on gross up income. Now, VA loan programs allow grossing up 25%.

Down Payment Assistance Programs

Down Payment Assistance programs go by the first mortgage loan type. So, an FHA first mortgage would be 15%, and everything else would be 25% unless a higher percentage is allowed for a VA first mortgage.

The gross up amount depends on the level of nontaxable vs. taxable income as totals. Lenders who use the Nontaxable Income Worksheet may figure a better income for helping borrowers qualify. We use it all the time to help more qualify!

Keep in mind that not all programs, lenders, or scenarios treat nontaxable income the same. So, this may vary, and even some may not use the fully allowed income. Check with OVM Financial about qualifying with your income!

OVM Financial or its affiliates do not provide tax, legal or accounting advice. This material is for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.