No state income tax in Tennessee: what lenders actually count

Folks who move here from another state love finding out that Tennessee doesn't take a cut of their paycheck. The Department of Revenue puts it plainly: Tennessee has no state income tax on earned income, so employers don't withhold it. The old Hall tax on investment income was repealed for tax years starting Jan. 1, 2021. So here's a fair question: does that help you get a mortgage?

The short answer: it helps your budget, not your ratio

Lenders figure your debt-to-income ratio on gross pay, before any taxes. A firefighter earning $60,000 is a $5,000-a-month borrower whether she lives in Tennessee or across the line in a state that withholds income tax. THDA caps that ratio at 45%.

Where no income tax does help is real life after closing. More of your check lands in your account, which makes the house payment easier to carry month to month. Just don't spend all of that cushion in your head yet. Tennessee collects in other ways:

• Sales tax: the state rate is 7% on most things, and local governments can add up to 2.75%. Food has a lower state rate of 4%.
• Property tax: set by your county and city, and paid through your escrow account. See the property tax guide for how a bill is figured.

What counts as income, piece by piece

Overtime: the first responder question

If you're a deputy in Rutherford County or a Memphis firefighter, overtime may be a big chunk of your pay. Lenders like it, but they want proof it's steady.

Under FHA, overtime can count with a two-year history, or at least one year if it was earned consistently and is likely to continue. The lender uses the lower of your two-year average or your most recent year. That's a built-in haircut when overtime is dropping.

Example only: a deputy earned $14,000 in overtime two years ago and $10,000 last year. The two-year average is $12,000, but last year was $10,000, so FHA counts $10,000, or about $833 a month on top of base pay.

Freddie Mac's rule is similar: if overtime is declining, the lender uses the lower recent level, and a drop of more than 10% means a closer look. Shift differential isn't named as its own category in any of the agency guides I checked, so your lender confirms how it reads yours.

The household income limit is a different test

Here's where people get mixed up. There are two separate questions:

1. Do you earn enough to afford the payment? That's the lender's debt ratio, using income that can be documented and counted.
2. Do you earn too much for THDA? That's the county income limit.

THDA's limits run by county and household size. In Davidson, Williamson, Rutherford, Sumner and Wilson counties, the limit is $139,320 for one or two people and $162,540 for three or more. In Shelby County it's $102,794 and $118,214. Many rural counties are at $94,900 and $109,200. Overtime that's too new to help you qualify might still count against you on the limit. Exactly which income THDA counts for the limit is something a THDA-approved lender confirms. Look up your county on the income limits page.

Student loans still show up

No state income tax doesn't make student loans go away. If your credit report shows a $0 payment on an income-driven plan, FHA has the lender use 0.5% of the balance instead. On $30,000, that's $150 a month in your ratio. Fannie Mae can accept a documented $0 payment, and Freddie Mac has a narrow exception near the end of Public Service Loan Forgiveness. Heroes loans are FHA, VA or USDA, so for most THDA buyers the FHA rule is the one that applies.

Moving to Tennessee for a new job

If you've just taken a job here, your work history still matters more than your address. FHA lets current income count after a gap of six months or more if you've been back in your line of work at least six months and had two years of work before the gap. Changing employers in the same field isn't a problem by itself. Changing careers takes more paperwork.

Also check the first-time buyer rule. If you owned a home in another state within the last three years, THDA treats you as a repeat buyer unless you buy in a targeted area or qualify as a veteran.

Retirement and disability income

Veterans with VA disability compensation sometimes have the most stable income of anyone at the closing table. It isn't taxed federally, and Tennessee doesn't tax wages either. Some lenders can increase nontaxable income for the ratio to reflect that it isn't taxed. Whether yours will, and by how much, isn't something I could verify in the agency guides, so ask. Disabled veterans may also qualify for state property tax relief calculated on up to $175,000 of value, which is covered in the property tax guide.

What to bring to your lender

• Your last 30 days of pay stubs and two years of W-2s.
• Your employer's breakdown of base pay and overtime, if they'll provide it.
• Tax returns if you have side income or a business.
• Award letters for any disability, pension or benefit income.
• Your student loan servicer's statement showing your plan and payment.

Self-employed or driving for an app? Read the self-employed buyer page or the gig worker page. Everyone else, check your eligibility and let a lender run your real numbers.

Things people ask

Keep reading

• Picking your Heroes Plus down payment option
• Ten-month paychecks, summer gaps and a THDA loan for teachers
• Buying near Fort Campbell with a VA loan and Homeownership for Heroes
• THDA's targeted counties and the first-time buyer rule
• Nashville, Memphis, Knoxville and Chattanooga: what a first home really costs
• Tennessee's transfer tax and mortgage tax at closing
• Property taxes on a Tennessee first home, and who gets relief
• USDA loans just past the city limits
• Getting every borrower to 640 for a THDA loan