Short answer: Non-taxable income — VA disability, BAH/BAS, Social Security, workers' compensation, some child support, some retirement — counts fully toward mortgage qualification. On conventional and FHA loans, it's typically grossed up by 25% because tax-free income has more purchasing power per dollar than taxable wages. On VA loans, non-taxable income is used at face value (no gross-up needed). For borrowers with substantial non-taxable income, this treatment often adds 20-30% to qualifying income compared to what an underwriter unfamiliar with the gross-up rules would count. The rule is Fannie Mae B3-3.1-01.
Why The Gross-Up Exists.
The intuition behind grossing up non-taxable income: a dollar of tax-free income is worth more than a dollar of taxable income because you don't pay federal/state/FICA tax on it. If a borrower nets $2,500/month from a $3,000/month taxable salary (after ~17% effective tax), then $2,500/month of tax-free income has equivalent purchasing power — but the mortgage industry doesn't want to require every borrower to compute their effective tax rate.
The compromise: use a standard 25% gross-up on documented non-taxable income. That factor approximates a mid-range effective tax rate and makes the math consistent across borrowers. Applied uniformly, it means a $2,000/month tax-free income source counts as $2,500/month for the qualifying income calculation ($2,000 × 1.25 = $2,500).
The rule appears in Fannie Mae Selling Guide B3-3.1-01 (General Income Information), Freddie Mac Selling Guide Section 5303, and HUD FHA Handbook 4000.1 Section II.A.4.d. All three sources permit the 25% standard; some lenders allow higher rates when the borrower's actual effective tax rate on equivalent taxable income would be higher.
What Non-Taxable Income Sources Qualify.
1. VA Disability Compensation.
Fully non-taxable per 38 U.S.C. § 5301. Grossed up 25% on conventional and FHA; used at face value on VA. Any rating (10% and above) counts. Monthly amounts depend on rating and dependents — a 50% rated veteran with a spouse might receive $1,225/month; a 100% rated veteran with a family might receive $4,200+/month. See our dedicated VA disability income article for the deep-dive.
2. Military BAH and BAS.
Basic Allowance for Housing and Basic Allowance for Subsistence are tax-free allowances for active-duty service members. BAH varies by rank, zip code, and dependents ($1,000-$5,000+/month range). BAS is smaller (~$460/month for enlisted). Both grossed up 25% on conventional/FHA; face value on VA. See our BAH mortgage income article for the specifics.
3. Social Security (Portions Non-Taxable).
Depending on the borrower's total income, up to 85% of Social Security benefits may be non-taxable federally. The non-taxable portion qualifies for gross-up on conventional and FHA loans. All types count: retirement Social Security, SSDI (disability), survivor benefits, and SSI (Supplemental Security Income). Documentation: SSA award letter plus recent Form 1099-SSA.
4. Workers' Compensation.
Non-taxable per IRC § 104(a)(1). Qualifies as mortgage income when documented and expected to continue for at least 3 years from loan closing. Permanent workers' comp awards for long-term disabilities qualify similarly to VA disability. Temporary workers' comp with a defined short end date typically doesn't clear the 3-year continuation test.
5. Some Child Support and Alimony.
Child support is generally not taxable to the recipient. Alimony (spousal support) is not taxable to the recipient for divorces finalized 2019 or later (post-TCJA). Both qualify as mortgage income when documented with a court order or divorce decree, evidence of consistent receipt for at least 6-12 months, and an expected continuation of at least 3 years. Grossed up 25% on conventional/FHA if non-taxable.
6. Some Retirement Income.
Distributions from a Roth IRA or Roth 401(k) are non-taxable and can be grossed up. Non-taxable portions of pensions (e.g., the return-of-basis portion for after-tax contributions) qualify. Standard pension distributions and Traditional IRA distributions are taxable and don't get the gross-up. The distinction: what's shown as taxable on Form 1099-R vs what's shown as non-taxable determines the treatment.
7. Railroad Retirement Tier 1.
The Tier 1 portion of Railroad Retirement Board benefits (equivalent to Social Security for railroad workers) has the same treatment as Social Security — partially non-taxable, grossed up 25%. Tier 2 is fully taxable and doesn't get the gross-up.
8. Other Less Common Sources.
- Combat-zone military pay (non-taxable for enlisted; portion non-taxable for officers)
- Foreign earned income exclusion (non-taxable up to the annual FEIE limit)
- Certain disability retirement pensions from state or local governments
- Some Native American tribal distributions
The Gross-Up Rate By Loan Program.
| Loan Program | Standard Gross-Up | Higher Rate Allowed? |
|---|---|---|
| VA Loan | None (face value) | N/A — VA already treats at true purchasing power |
| Conventional (Fannie Mae) | 25% | Yes — up to the borrower's documented effective tax rate |
| Conventional (Freddie Mac) | 25% | Yes — same as Fannie Mae rule |
| FHA | 25% (some lenders default to 15%) | Yes — same standard |
| USDA | 25% | Same as conventional |
| Non-QM | Program-specific; often not applicable (deposit-based) | Depends on program |
Note the FHA quirk: while HUD's guideline permits the 25% gross-up, some FHA-focused lenders default to 15%. Always ask specifically what gross-up rate is being applied. The difference between 15% and 25% on a $30,000/year non-taxable income source is $3,000 of qualifying income — enough to shift a pre-approval by roughly $20,000-$25,000 depending on rate environment.
The Higher-Than-25% Path.
Fannie Mae B3-3.1-01 permits grossing up at the borrower's actual effective tax rate rather than the 25% default when the borrower's tax returns clearly document that rate. This matters for higher-income borrowers whose effective tax rate exceeds 25%.
Example: a physician with $180,000/year in taxable salary and a documented effective tax rate of 32% could potentially gross up her $12,000/year in Roth IRA distributions at 32% ($12,000 × 1.32 = $15,840) rather than 25% ($15,000). The difference is small on this specific example, but for a borrower with substantial non-taxable income the 7-percentage-point delta matters.
Documentation for the higher rate: 2 years of tax returns showing the effective rate calculation. Most lenders default to 25% for simplicity; specifically request the higher rate calculation if it applies to your situation.
The Continuation Test.
All non-taxable income must be reasonably expected to continue for at least 3 years from loan closing. This test matters differently for each source:
- VA disability: passes automatically for permanent ratings and for ratings that have been held 5+ years (10+ years at 60%+); ratings under 5 years old need supporting documentation showing they're not scheduled for reduction
- BAH: passes for the current active-duty term; if the service member is close to separation date without extension, continuation may fail
- Social Security retirement: passes automatically (continues for life)
- SSDI: passes when the disability is permanent; may require additional documentation for time-limited awards
- Workers' comp: passes for permanent awards; temporary awards with defined end dates within 3 years typically fail
- Child support: passes only if the youngest supported child will be under 18 for at least 3 more years OR the court order specifies support continues past 18 (college support)
- Alimony: passes if the court order specifies continuation for at least 3 more years
Documentation Package By Source.
VA disability: VA Benefit Summary Letter (free download from va.gov Records → Download VA Letters), plus 2 months of bank statements showing monthly VA deposits.
BAH/BAS: current LES from your unit + Statement of Service confirming active-duty status.
Social Security: SSA award letter (from ssa.gov) + most recent Form 1099-SSA showing benefit amount + 2 months of bank statements showing deposits.
Workers' comp: award letter from the workers' comp carrier or state agency + evidence of monthly payment consistency.
Child support/alimony: divorce decree or court order + 6-12 months of bank statements showing deposits + written statement of expected continuation.
Roth or non-taxable retirement: most recent Form 1099-R (with "distribution code" showing non-taxable status) + account statement showing balance capable of supporting continued distributions.
Common Mistakes.
Not asking what gross-up rate applies. Many borrowers don't know gross-up exists; loan officers who don't specialize in these files may default to the lowest rate their institution allows without offering higher.
Assuming ALL non-taxable income qualifies. Cash gifts, income from illegal sources, and untaxed cash income don't qualify. The rule is about legally non-taxable income that's documented and expected to continue — not "income you didn't report on taxes."
Failing the continuation test on time-limited income. A workers' comp award with 18 months remaining, or child support for a 16-year-old with no college-support clause, fails the 3-year test and typically can't be counted.
Not documenting the non-taxable classification. Some retirement income is partially taxable and partially non-taxable. Only the non-taxable portion gets grossed up. Provide the 1099-R with clear distribution codes.
Real Example: 70%-Rated Veteran With BAH And Roth Distributions.
Consider a 70%-rated combat veteran, currently active-duty Army, receiving VA disability while continuing to serve, with a Roth IRA he's begun drawing from:
- Active-duty base pay: $58,000/year (taxable)
- BAH (Fort Bragg, with dependents): $2,300/month = $27,600/year (non-taxable)
- BAS: $5,200/year (non-taxable)
- VA disability (70% with spouse and one child): $1,880/month = $22,560/year (non-taxable)
- Roth IRA distribution: $6,000/year (non-taxable)
Face-value total (VA loan): $58,000 + $27,600 + $5,200 + $22,560 + $6,000 = $119,360/year
Conventional loan with 25% gross-up on non-taxable:
- Taxable base: $58,000
- Grossed-up non-taxable: ($27,600 + $5,200 + $22,560 + $6,000) × 1.25 = $61,360 × 1.25 = $76,700
- Total qualifying income: $134,700
The gross-up added $15,340/year of qualifying income on the conventional path — worth roughly $110,000-$135,000 of additional buying power depending on rate environment. This is money that was already in the veteran's real budget; the gross-up simply reflects it correctly for underwriting purposes.
Non-Taxable Income + VA Funding Fee Waiver.
For veterans with a VA disability rating of 10% or higher, an additional benefit: the VA funding fee is entirely waived. On a $500,000 VA purchase loan, that saves $11,500-$16,500 at closing depending on first-use vs subsequent-use status. Combined with counting VA disability at face value in the qualifying calculation, veterans with disability ratings often find VA is the strictly better loan program even when conventional theoretically produces a higher gross-up figure.
FAQ.
What is a mortgage income gross-up?
A gross-up is an adjustment mortgage underwriting applies to non-taxable income to reflect that tax-free income has more spending power per dollar than taxable wages. Conventional and FHA loans typically gross up non-taxable income by 25%, meaning $1,000/month of tax-free income counts as $1,250/month for qualifying purposes. VA loans don't apply a gross-up because VA underwriting already treats non-taxable income at its true purchasing power.
What types of non-taxable income can be grossed up for a mortgage?
The most common qualifying non-taxable income sources: VA disability compensation, the non-taxable portion of Social Security benefits, military BAH (Basic Allowance for Housing) and BAS (Basic Allowance for Subsistence), workers' compensation, some retirement income (Roth distributions, non-taxable portion of pensions), some child support and alimony where non-taxable, and railroad retirement Tier 1. Each source has its own documentation requirements.
Do all lenders gross up non-taxable income at 25%?
25% is the most common standard and matches the effective tax rate assumption Fannie Mae and Freddie Mac permit. Some lenders will gross up at a higher rate (up to 30% or even the borrower's actual effective tax rate documented on tax returns) when the borrower can prove their effective tax rate would be higher on equivalent taxable income. Some FHA lenders default to a 15% gross-up. Ask specifically what gross-up rate your lender is using — the difference between 15% and 25% on a $30,000/year non-taxable income source is $3,000 of qualifying income, worth about $22,000 of additional buying power.
How much documentation do I need for non-taxable income?
Depends on the source. VA disability: VA Benefit Summary Letter (downloadable from va.gov). Social Security: SSA award letter plus recent Form 1099-SSA. BAH/BAS: current LES from your unit. Workers' comp: award letter from the workers' compensation carrier or state agency. Child support/alimony: divorce decree or court order + 6-12 months of documented receipt via bank deposits. Each source also typically needs evidence the income will continue for at least 3 years from loan closing.
Does Social Security count as mortgage income if I'm not yet retirement age?
Yes if you're currently receiving it. Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI) both qualify as mortgage income when documented with an award letter and expected to continue for at least 3 years. Social Security survivor benefits for a widowed spouse also qualify. Retirement-age Social Security benefits qualify regardless of the borrower's current age. Some portion of Social Security is non-taxable and can be grossed up 25% on conventional loans.
Can workers' compensation income be used for a mortgage?
Yes when it's documented, non-taxable, and expected to continue for at least 3 years. Permanent workers' comp awards for long-term disabilities qualify similarly to VA disability compensation — grossed up 25% on conventional and FHA, used at face value on VA. Temporary or partial workers' comp with a defined end date typically doesn't count because it fails the 3-year continuation test. Document with the state workers' comp agency's award letter or the private carrier's award letter.
Sources & Primary References.
- Fannie Mae Selling Guide B3-3.1-01 — General Income Information (non-taxable income treatment and gross-up rules)
- Freddie Mac Single-Family Seller/Servicer Guide Section 5303 — Non-taxable income
- HUD FHA Handbook 4000.1 Section II.A.4.d — Non-taxable and grossed-up income
- VA Pamphlet 26-7 Chapter 4 — VA underwriting (non-taxable income at face value)
- 26 U.S.C. § 104(a)(1) — Workers' compensation federal tax exemption
- 38 U.S.C. § 5301 — VA disability compensation federal tax exemption