Lenders ask to see recent paystubs to verify your monthly net wages which they use as a basis for figuring your monthly income. They often ask to see more than one stub because it helps them gauge your wages more accurately – that is you can’t inflate your income by showing an unusual month with more hours or with an annual bonus or some such thing. Monthly income is important because lenders use it to figure your debt to income ratio.
Your debt ratio is the ratio of personal debt to income – in other words, it provides a simple representation of your net income. Ideally, the ratio will be greater than one. If it is greater than one, it means that you have enough income to pay your debts and make other routine payments such as those necessary for utilities, food, and entertainment. If you have a ratio of less than one, you do not have enough income to make your debt payments, let alone those other expenses. Not surprisingly, a lender does not want to lend to someone who does not have enough income to pay off all his debt. Instead, a lender prefers to see a ratio of about 1.3, which means you have about 30% more money than you need to pay your debt. The lender considers this a comfortable margin for you not to be tempted to use your mortgage money to go on vacation or pay medical bills or go out to dinner.
As stated above, pay stubs verify your monthly wages but don’t provide the complete picture of your monthly net income, which is really what lenders are interested in. Your monthly net income equals everything that comes in minus everything that goes out. So, to figure everything that comes in, lenders check to see if you have any non-wage income that supplements your wages such as stock dividends, trust distributions or government benefits. They’ll look at your credit report and tax returns to help determine everything that goes out. Credit reports help lenders figure how much debt you owe and pay off monthly, and tax returns help lenders find hidden expenses such as medical expenses and charitable donations. All this information allows them to get the most accurate figure for your monthly income and thus minimizes their risk in lending to you. It all starts with the recent pay stubs, by they need so much more information to get the complete picture.
There are a few fairly simple reasons that lenders want to see recent paystubs, some of them obvious, some of them not so obvious.
The most obvious is to make sure that you are still employed. If you apply for a loan on June 2nd and state in your application that you are currently employed as the Chief Bottle Washer at the Acme Widget Company, there is no reason that you shouldn’t be able to provide copies of your paystubs from May — unless you’re lying and really haven’t worked there since March.
Another reason, also related to fraud prevention, is to make sure the numbers match up. If someone says on their application that they’ve been employed at a salary of $100,000 and have worked at the same company in the same position for two years, a recent paystub should show year-to-date earnings consistent with the information provided on the application. Thus, if that individual’s pay stubs for May show year-to-date earnings of $10,000, there is an inconsistency that needs to be explained and documented to the underwriter’s satisfaction. If that cannot be done (con artists aren’t always as clever as they think they are), it’s quite possible that someone will initiate a fraud investigation.
It’s pretty much a question of common sense: If you were going to loan someone a significant amount of money, wouldn’t you want them to demonstrate to your satisfaction that they had the ability to pay the money back?