Capital Gains and Mortgage Approval

Navigating Fannie, Freddie, and FHA Guidelines

For some individuals, capital gains income can be a crucial component in demonstrating financial stability during mortgage applications. If you are a real estate investor or earn income through asset sales, you may be eligible to use capital gains to qualify for a mortgage. Each agency—Fannie Mae, Freddie Mac, and FHA—has distinct guidelines regarding how capital gains income can be used. This article explores these requirements, highlighting how lenders review capital gains, and the documentation needed to ensure a smoother loan approval process.

Fannie Mae: Flexible but Thorough

Fannie Mae allows borrowers to use capital gains income as long as they meet specific requirements. Here’s a breakdown of the key criteria:

History of Capital Gains Receipt

Fannie Mae requires borrowers to show a two-year history of receipt of capital gains income. This helps establish a track record, showing that income generated from asset sales isn’t a one-time event. The borrower should provide two years of federal income tax returns, including IRS Form 1040, Schedule D, which details capital gains or losses. While current capital gains income isn’t mandatory, the lender must verify that the borrower still holds assets likely to generate future gains.

Income Continuity and Stability

Fannie Mae’s guidelines prioritize income stability and predictability. The lender needs to feel confident that this income will continue. For this reason, they will typically look at the income trend over the past two years. If capital gains are stable or increasing, the income may be averaged over 24 months. However, if the income shows a decline, only the lower, current level of income can be used, as it suggests uncertainty about future gains. In cases where the trend is downward, further analysis is required before the income can be counted toward qualifying for the mortgage.

Documentation Requirements

Beyond the two years of tax returns, lenders may also need to document that the borrower possesses additional assets that could potentially be sold in the future. This helps reinforce the income continuity requirement and gives the lender assurance that funds will be available for mortgage payments if needed.

Key Points

• Two-year history of capital gains is mandatory.
• Income trends must be stable or increasing.
• Borrowers must have sufficient assets to show potential for future income generation.

Fannie Mae’s approach is ideal for borrowers with significant asset holdings who may have less traditional income sources.

Freddie Mac: Stability and Sufficient Assets

Freddie Mac also allows borrowers to use capital gains income for mortgage qualification, but with some distinctions from Fannie Mae’s requirements.

History of Receipt

Similar to Fannie Mae, Freddie Mac requires a two-year history of capital gains. This history is documented through two years of federal income tax returns, ensuring consistency and reliability in the borrower’s income from asset sales.

Income Continuity

Freddie Mac is particularly attentive to continuity. In addition to historical income, they require documentation that sufficient assets remain post-closing to support the borrower’s capital gains income for at least three more years. This safeguard ensures that the borrower’s financial position is strong enough to continue generating capital gains income. If asset levels post-closing do not appear sufficient, the lender might not count capital gains as part of the qualifying income.

Calculation Method

Freddie Mac uses a straightforward 24-month average of capital gains income. This averaging method provides stability, making it easier for borrowers to qualify. However, if the income demonstrates a downward trend, lenders may adjust the qualifying income accordingly, potentially affecting the borrower’s eligibility or loan amount.

Documentation

Along with tax returns, Freddie Mac also requires evidence of sufficient assets post-closing. This can include bank or brokerage statements showing asset holdings that could generate future gains.

Key Points

• Two-year history of capital gains income is necessary.
• Three years’ worth of assets should remain post-closing to ensure income continuity.
• A 24-month average of capital gains income is used to determine qualifying income.

Freddie Mac’s approach is beneficial for borrowers who have a strong asset base and can prove their ability to generate ongoing income.

FHA: Rigorous Documentation for Broader Inclusion

FHA loans are well-known for their inclusivity and flexibility, and they extend these attributes to capital gains income, though with some unique requirements.

History of Receipt

The FHA requires borrowers to provide a three-year history of capital gains income. This extended timeframe offers additional insight into the consistency and sustainability of the income source, especially if the borrower relies primarily on capital gains.

Continuity and Stability

FHA guidelines emphasize stability and continuity. For capital gains to be included as effective income, they must show an increasing or stable trend over the three-year period. If capital gains income consistently results in losses, it must be deducted from the borrower’s total income. This conservative approach helps FHA ensure that only reliable income sources are included, safeguarding against potential borrower default.

Calculation and Documentation

FHA requires a longer documentation trail, with three years of tax returns needed. This helps them evaluate income trends over an extended period. If capital gains reflect a consistent gain, it can be added to effective income. However, if losses are persistent, it impacts the borrower’s total qualifying income negatively, as the lender will deduct it rather than add to it.

Key Points

• Three-year history of capital gains income is required.
• Capital gains income is only added if there is a consistent trend of gains.
• Losses in capital gains must be deducted from qualifying income.

FHA’s method works well for borrowers who have a stable, long-term record of capital gains income but may face stricter guidelines than those required by Fannie Mae or Freddie Mac.

Why Capital Gains Income Requirements Vary

The requirements for capital gains income vary between Fannie Mae, Freddie Mac, and FHA due to their differing missions and risk tolerance. Fannie Mae and Freddie Mac, as government-sponsored enterprises (GSEs), prioritize low-risk, predictable income streams, making them somewhat flexible but thorough in documentation and asset requirements. The FHA, on the other hand, is focused on inclusivity and broad accessibility, which is why they have slightly stricter guidelines for evaluating non-traditional income sources like capital gains.

Common Documentation Needs Across Agencies

Regardless of the agency, there are standard documentation practices that borrowers should anticipate:

• Tax Returns: All three agencies require recent tax returns to verify the borrower’s income consistency.
• Proof of Asset Ownership: For ongoing income continuity, borrowers must document that they possess sufficient assets that could generate future capital gains if necessary.
• Income Trend Analysis: Lenders evaluate whether the income trend is stable, increasing, or declining. Declining trends may impact eligibility or reduce the qualifying income amount.

Steps to Maximize Approval Chances with Capital Gains Income

Using capital gains to qualify for a mortgage can be complex, but careful preparation can improve approval chances:

• Gather Documentation: Collect the required tax returns, bank statements, and brokerage statements in advance. This will provide your lender with the evidence they need to verify income and asset ownership.
• Show Strong Assets: Demonstrate that you have substantial assets remaining post-closing to ensure income continuity.
• Evaluate Your Income Trend: Review your capital gains income trend over the required timeframe to ensure it’s stable or increasing. This can help avoid complications during the underwriting process.

How Innovative Mortgage Brokers Can Help

At Innovative Mortgage Brokers, we understand the challenges associated with qualifying for a mortgage using capital gains income. Our team is experienced in navigating the unique guidelines set by Fannie Mae, Freddie Mac, and FHA. We help our clients gather and present the necessary documentation to maximize their chances of approval for a mortgage in Pennsylvania (PA) or Florida (FL). By working closely with you, we ensure that you’re well-prepared and informed every step of the way.

With our in-depth knowledge of the requirements around capital gains income, and options we have available, we help you structure your application to highlight financial stability and eligibility. Whether it’s advising on income consistency, assisting in the review of tax documents, or ensuring your investment income meets all necessary criteria, our goal is to make the process as straightforward as possible. At Innovative Mortgage Brokers, we’re dedicated to providing personalized guidance to turn your needs into a pathway to homeownership, giving you a strong foundation for a successful mortgage loan.

Final Thoughts

Capital gains income can be a valuable asset when applying for a mortgage, but it requires careful planning and documentation. Understanding the specific guidelines set by different agencies will help you determine which agency’s requirements align best with your financial profile. With the right preparation, borrowers who rely on capital gains can successfully qualify for a mortgage and achieve their homeownership goals. Reach out to us today for guidance on using capital gains income to help you secure your next mortgage in Pennsylvania (PA) or Florida (FL).