What Is Effective Income?

Definition and Examples of Effective Income

When the FHA looks at your effective income to determine whether to grant you an FHA loan, it considers the gross income that is found on your tax return. This income may come from a variety of sources such as your salary, hourly wages, overtime, bonuses, tips, and commissions. The FHA will also consider any employer-provided mortgage assistance. 

You will need to prove your work history and income for the past two years through employment verifications, W-2 forms, and paystubs. If you’ve changed your employer or line of work within a year, the FHA may require further documentation and verification. 

The FHA may also consider the income you earned if you’ve worked a part-time job for the past two years and will probably continue to do so. To be approved for a loan, the FHA must believe that your income is likely to continue for at least the initial three years of the mortgage.

When it comes to rental properties, effective gross income (EGI) is the potential gross rental income you can earn minus any vacancies, renovation costs, or unpaid rents. 

How Does Effective Income Work?

Essentially, effective income is any income that you’re actually earning when you apply for an FHA mortgage. It can give the FHA a good idea of what kind of borrower you may be and whether you’ll be able to repay your loan. 

Let's pretend you’ve worked an inside sales job at an office supply company for the past five years. When you look at documents that show your earnings, you notice the following numbers:

• Salary: $47,000
• Commissions: $6,500
• Bonuses: $3,200

In this scenario, your effective income is the total of those three numbers, or $56,700. 

When it comes to rental properties, your EGI is the income a property earns plus income from other sources. If you own a rental property, it’s the total of all the money you collect from things like rent, late fees, vending machines, laundry machines, parking fees, pet fees, and more after you subtract all current or predicted vacancies and credits.

For example, if you rent a one-bedroom condo to someone for $1,000 per month, you may expect to bring in an EGI of $12,000 per year ($1,000 x 12 months). However, if that person doesn’t pay their rent one month, then the actual EGI from that rental property would be $11,000 for the year. Two rental properties with the same monthly rent price could result in different effective incomes if tenants vacate the property, rent goes unpaid, or something else happens and income is lost.

Effective Income vs. Total Annual Income

As mentioned above, effective income can apply to the calculation the FHA uses to determine your eligibility for a mortgage. Effective gross income (EGI) relates to rental properties and can include much more than just rent.

Annual income is what is used to determine whether a family is eligible for assisted housing. It includes all income (both monetary and not) that is received by family members as well as all income that is expected to be received from outside family sources during the 12 months after the admission or annual recertification date. As a rental property owner, it’s your responsibility to figure out a family’s annual income before you allow them to move into assisted housing. 

Frequently Asked Questions (FAQs)