What Borrowers Should Know about Incentive Income

Did you know that incentive income, or income awarded for results rather than time worked, doesn’t factor into your overall income the same way a salary would? This distinction could affect how much you’re eligible to spend on a new home.

For example, if you make $200,000 a year and find that only $150,000 applies to your home loan application, you may rethink the timing, structure, and size of your loan.

To ensure as much of your income is accounted for during the loan application process, it’s important to understand the types of incentive income, how your eligibility will be considered, and how this could affect timing when moving into your next home.

Incentive Income Types

First, it’s important to understand what pieces of your compensation are considered income incentive. There are three common types of incentive-based income:

  • Bonus compensation
  • Commission
  • Profit-related pay or share ownership

According to the Harvard Business Review’s analysis, “Performance-related pay was positively associated with job satisfaction, organizational commitment, and trust in management.”

Incentive pay can be a valuable tool for motivating salespeople, and is also popular with startups where employees are rewarded for helping grow a company.

Bonus income represents performance-based or discretionary income paid in addition to your base income. It is traditionally paid once a year but can be paid at different intervals and can be based on many factors, and some companies set an expected percentage as part of a larger compensation package, often correlated with team or corporate performance.

Commission income, on the other hand, is an employee’s cut on a certain transaction, is based on individual performance, and is typically paid out monthly. An example of this may be income based on sales goals.

Profit-related pay or share ownership is often offered in lieu of a cash bonus, such as units of equity in the company, and come with a vesting schedule that determines when you can convert that stock into cash.

Not sure how much home you can afford? Use our easy calculator to find out.

How Incentive Income is Considered

Incentive income is valid income that can be applied to your home loan application. For a lender to determine if your incentive income will be considered, three requirements must be met.

  • History: In most cases, a pattern must be established to prove you have a minimum of a two-year history at your current company or employer.
  • Amount and Continuity: The amount must be verified based on the pattern or trend over the past two years. If the amount earned over the past two years has increased, an average will likely be taken from the historical data over the past two years. Conversely, if the incentive income has decreased, only the most recent year will be considered.
  • Ongoing Eligibility: Finally, it’s critical to provide evidence that a similar level of incentive income is likely to continue for three years or more.

Worth the Wait?

Because a two-year, established pattern or history is required, a new job or an increase in pay within the last year may not generate the type of qualifying income you may expect.

For example, if you have been at the same company for six years but just recently got a promotion, your new commission amount will likely be the average of the past two years rather than the amount you’re earning now. You could also work with your company to provide proof that your commission structure is expected to continue at the new, higher amount or increase over time.

So even if you’re making more income overall, it may benefit you to wait until you have two years proof with this higher income structure to apply for a loan depending on the amount you hope to borrow. In the same vein, if your bonus commission decreased last year, it may help to wait until this amount increases before applying for a home loan.

Acing the Bonus Question

In summary, incentive income is any income outside your consistent salaried pay and consistency is key in having that income aid your home loan application. Knowing the type of incentive income, how that type of income is considered in a mortgage application, and whether your compensation is expected to continue longer-term, you can make a more informed decision on when to move forward with your loan.

Before applying, work with your loan officer to analyze these three factors well to time an application strategically and qualify for the home that best suits your needs.