Documenting your income is a basic part of applying for a mortgage. But there's more to it than just handing over a couple of paystubs. You need to be able to show your earnings are stable. And in making a down payment, you may have to be able to show where that money came from as well.

If you're a recent graduate who's landed a well-paying job, or someone who recently switched careers or started a business, you may have trouble qualifying for a conventional mortgage no matter how much you're earning.

How much income do you need?

Let's start with the basics. The rule of thumb is that your monthly housing expenses, including the mortgage, property taxes and homeowner's insurance, shouldn't exceed 28 percent of your monthly income and your total debt payments - adding in things like credit cards and a car loan - shouldn't exceed 36 percent.

Those figures aren't hard and fast, however. Some lenders may allow higher ratios and others may allow you to exceed their own limits on the mortgage if your total debt is low or if you have a great credit history.

Two-year history desired

To document your income, your lender will likely require a couple of recent paycheck stubs (or their electronic equivalent) and your most recent W-2 form. But the real documentation will be in the form of your last two years of federal tax returns, which the lender will obtain directly from the IRS. You'll be asked to sign a Form 4056-T to authorize the IRS to release them to your lender.

Your lender will want to see at least two years of steady income before they're authorize a mortgage. That means no gaps in employment during that time. It's ok if you've changed jobs, but only if you stay in the same field. If you've made a major change - say, leaving a sales job to become a teacher or vice versa - you'll likely be turned down if you've been there less than two years. These days, mortgage lenders are all about stability and they'll want to be assured that your new career is working out before approving your loan.

Documenting self-employed income

For the self-employed, your tax returns will also be your main form of income verification, though you may also be required to file a profit-and-loss statement for your business. Once again, they'll want to see at least a two-year history in the business, with stable or rising income.

They'll take your average income over the past two years, so total that and divide by 24 to get your monthly income for mortgage qualification purposes. Keep in mind, though, that any business deductions you take on your federal tax return lowers your income for purposes of obtaining a mortgage - which often limits self-employed people to a smaller mortgage that they might like and still comfortably afford.

One way around this is to seek a stated income mortgage through a private lender, rather than a more conventional mortgage backed by an entity like the FHA, Fannie Mae or Freddie Mac. Stated income loans are much harder to find than they were before the housing bubble burst, but some specialty lenders still offer them. You'll pay a premium rate and will need excellent credit and substantial financial assets to qualify, but it is an option for obtaining a larger mortgage when you're self-employed.

If you received money for a down payment

Finally, if you recently received a large sum of money that you're planning to use for your down payment, you'll need to be able to document how you obtained that as well. If it was a gift from your parents or other relatives, you'll need a "gift letter" from them stating the money is truly a gift and that you are not obligated to repay it.

If you sold a second car to raise the money, you'll need to show the bill of sale. The key thing for lenders is making sure the money is truly yours and not part of an under-the-table financing arrangement reached with the sellers or a private loan you will be responsible for repaying, in addition to the mortgage.

Published on April 18, 2011