INCOME QUALIFICATION
I want to determine your usable income for qualification. It is not uncommon that some clients income cannot be used, therefore, I want to do this up-front to avoid any surprises. Below are the basics that I will be following. Let me know if you have any questions! Ray
Stable & Predicatable Income
Examples: Salary, SSI, Annuity...
The stable and reliable flow of income is a key consideration in mortgage loan underwriting. Individuals who change jobs frequently, but who are nevertheless able to earn consistent and predictable income, are also considered to have a reliable flow of income for qualifying purposes.
To demonstrate the likelihood that a consistent level of income will continue to be received for borrowers with less predictable sources of income, we must obtain information about prior earnings, such as commissions, bonuses, overtime, or employment that is subject to time limits, such as contract employees or tradesmen.
variable income
Examples: Hourly, bonus, overtime…
All income that is calculated by an averaging method must be reviewed to assess the borrower’s history of receipt, the frequency of payment, and the trending of the amount of income being received.
Examples include hourly workers, or income that includes commissions, bonuses, or overtime.
History of Receipt:
2+ years of receipt of a particular type of variable income is recommended.
If received 1+ year maybe considered as long as the loan application demonstrates that there are positive factors that reasonably offset the shorter income history.
Income Trending - Basic
If the trend in the amount of income is stable or increasing, the income amount should be averaged.
If the trend was declining, but has since stabilized and there is no reason to believe that the borrower will not continue to be employed at the current level, the current, lower amount of variable income can be used.
If the trend is declining, the income may not be stable. Additional analysis must be conducted to determine if any variable income can be used, but in no instance may it be averaged over the period when the declination occurred.
3-Year Continuance
The following must be projected to be received for 3+ years from date of closing or mortgage application depending on income, to be used for qualification.
Alimony, Child Support, or Separate Maintenance.
Distributions from a retirement account – for example, 401(k), IRA, SEP, Keogh
Mortgage differential payments
Notes receivable
Public assistance
Restricted Stock & Restricted Stock Units subject to time vesting (Freddie)
Royalty payment income
Social Security
Long-term disability
Trust income
VA benefits (not including retirement or long-term disability)
Capital gains
Dividend and interest
Homeownership Voucher Program (HOV)
Income Types
Automobile Allowance
Allowed if stable and can verify 2-years receipt and current.
Foreign Income
Copies of signed US Federal Tax Returns for recent 2-years that include foreign income.
All documents of a foreign origin must be completed in English, or translated, and ensure the translation is complete and accurate.
Income must be translated into U.S. dollars.
Foster Care Income
Verify the foster-care income with letters of verification from the organizations providing the income.2
Document that the borrower has a 2-year history of providing foster-care services. If the borrower has not been receiving this type of income for two full years, the income may still be counted as stable income if
Borrower has at least a 12-month history of providing foster-care services, and
The income does not represent more than 30% of the total gross income that is used to qualify for the mortgage loan.
Housing or Parsonage Allowance
May be considered qualifying income if there is documentation that it has been received for the most recent 12-months and the allowance is likely to continue for the next 3-years.
Income may be added to income, but not used to offset the monthly housing payment.
Note: This requirement does not apply to military quarters’ allowance. For information on military housing, refer to Base Pay (Salary or Hourly), Bonus, and Overtime Income.
Mortgage Differential Payment Income
An employer may subsidize an employee’s mortgage payments by paying all or part of the interest differential between the employee’s present and proposed mortgage payments.
Expected to continue for a minimum of 3-years from the date of the mortgage application.
If this income is used on a purchase transaction, current receipt is not required to be documented except as verified in the employer letter. For refinance transactions where the income is continuing with the new loan, the recent receipt must be in compliance with the Allowable Age of Credit Documents policy (see, Allowable Age of Credit Documents and Federal Income Tax Returns, for additional information).
Non-Occupant Co-Borrower Income
A non-occupant borrower’s income as qualifying income for a principal residence with certain LTV ratio limitations.
This income can offset certain weaknesses that may be in the occupant borrower’s loan application, such as limited income, financial reserves, or limited credit history. However, it may not be used to offset significant or recent instances of major derogatory credit in the occupant borrower’s credit history. The occupant borrower must still reasonably demonstrate a willingness to make the mortgage payments and maintain homeownership. If the income from a non-occupant borrower is used for qualifying, the LTV ratios are limited.
Public Assistance Income
Verification of Public Assistance Income
Document the borrower’s receipt of public assistance income with letters or exhibits from the paying agency that state the amount, frequency, and duration of the benefit payments.
Verify that the income can be expected to continue for a minimum of 3-three years from the date of the mortgage application.
Section 8 Payment Vouchers
Determine from the public agency that issues the vouchers the monthly payment amount and whether the income is nontaxable.
If the income is nontaxable, can develop an adjusted gross income for the borrower. See, General Income Information, for additional information.
Income from Unemployment Benefits
Typically short-term in nature and can be considered when qualifying the borrower in the following scenarios:
The income has been consistently received for at least 2-years as verified by copies of the signed federal income tax returns that reflect the unemployment income is associated with seasonal employment.
Royalty Payment Income
Royalty contract, agreement, or statement confirming amount, frequency, and duration of the income; and
Most recent signed federal income tax return, including the related IRS Form 1040, Schedule E.
Schedule K-1 Income
Reflects a documented, stable history of receiving cash distributions of income from the business consistent with the level of business income being used to qualify, then no further documentation of access to the income or adequate business liquidity is required. The Schedule K-1 income may then be included in the borrower’s cash flow.
If the Schedule K-1 does not reflect a documented, stable history of receiving cash distributions of income from the business consistent with the level of business income being used to qualify, then we must confirm the business has adequate liquidity to support the withdrawal of earnings.
If the borrower has a two-year history of receiving “guaranteed payments to the partner” from a partnership or an LLC, these payments can be added to the borrower’s cash flow.
Note: An exception to the two-year requirement of receiving “guaranteed payments to the partner” is if a borrower has recently acquired nominal ownership in a professional services partnership (for example, a medical practice or a law firm) after having an established employment history with the partnership. In this situation, we may rely on the borrower’s guaranteed compensation. This must be evidenced by the borrower’s partnership agreement and further supported by evidence of current year-to-date income.
Temporary Leave Income
Generally employee-initiated, short in duration and for reasons including, but not limited to maternity or parental leave, short-term medical disability, or other temporary leave types that are acceptable by law or to the borrower’s employer.
Borrower may or may not be paid during their absence from work.
Borrower must provide written confirmation of his or her intent to return to work.
Verbal verification of employment in accordance with, Verbal Verification of Employment. If the employer confirms the borrower is currently on temporary leave, we must consider the borrower employed.
Required:
The amount and duration of the borrower's “temporary leave income,” which may require multiple documents or sources depending on the type and duration of the leave period; and
The amount of the “regular employment income” the borrower received prior to the temporary leave. Regular employment income includes, but is not limited to, the income the borrower receives from employment on a regular basis that is eligible for qualifying purposes (for example, base pay, commissions, and bonus).
Note: Income verification may be provided by the borrower, by the borrower's employer, or by a third-party employment verification vendor.
Tip Income
We need a completed Request for Verification of Employment or borrower’s recent paystub, and
IRS W-2 forms covering the most recent 2-year period or the most recent 2-years tax returns with IRS Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to verify tips not reported by the employer.
Trust Income
Confirm continuance of income. This confirmation must be based on the type of income received through the trust. For example, if the income from the trust is derived from rental income, then the 3-year continuance is not required. However, if the income is a fixed payment derived from a depleting asset, then 3-year continuance must be determined.
If any assets from the trust are being used for down payment, closing costs, or reserves, those assets must be subtracted from the total amount before determining if the trust income meets the Continuity of Income requirements.
If eligible employment-related assets have been liquidated and placed into a trust within 12-months of the loan’s application date, the income calculation requirements in Employment-Related Assets as Qualifying Income apply.
Requirements for Trust with Fixed Payments
Use the fixed payment amount from the trust agreement as the borrower’s qualifying income, converting it to a monthly amount, as applicable.
Document current receipt of trust income with one month’s bank statement or other equivalent documentation.
Payments must have been received for 12-months or longer to be considered stable monthly income, unless the following requirements are met:
the trust documentation reflects fixed payments,
the borrower is not the grantor, and
at least one payment is received prior to closing.
Requirements for Trust with Variable Payments
Calculate the qualifying income amount per Variable Income guidelines
Document the following:
a minimum 24-month history of trust income by obtaining copies of the borrower’s signed federal tax income tax returns for the most recent two years, and
current receipt of trust income with one month’s bank statement or other equivalent documentation.
VA Income
Verify that the income can be expected to continue for a minimum of three years from the date of the mortgage application.
Rental Income
Rental income is an acceptable source of stable income if it can be established that the income is likely to continue. If the rental income is derived from the subject property, the property must be one of the following:
a two-to four-unit principal residence property in which the borrower occupies one of the units, or
a one-to four-unit investment property.
If the income is derived from a property that is not the subject property, there are no restrictions on the property type. For example, rental income from a commercial property owned by the borrower is acceptable if the income otherwise meets all other requirements (it can be documented in accordance with the requirements below).
Union Workers:
For union members who works in an occupation that results in a series of short-term job assignments (such as a skilled construction worker, longshoreman, or stagehand), the union may provide the executed employment offer or contract for future employment.
The borrower’s start date must be no earlier than 30 days prior to the note date or no later than 90 days after the note date.
6-months reserves for PITI.
1099 Employee/Independent Contractor
At times, Borrowers receive IRS Form 1099(s) for services performed; this pay structure is often referred to in terms such as contractor or contingent worker. Income received on IRS Form 1099 for services performed may be reported on Schedule C and may represent a sole proprietorship.
If the Underwriter determines that the Borrower is a sole proprietor. Factors the Underwriter may consider when determining whether income reported on Schedule C is representative of a sole proprietorship include, but are not limited to, the principal business or profession, gross receipts or sales, cost of goods sold and the type and level of expenses reported.
Documentation Requirements:
All 1099s for the most recent two-year period, and
YTD paystubs or YTD earnings statements received by the Borrower, and
Complete federal individual income tax returns covering the most recent one-year period, and
The Underwriter must determine if more information and documentation is needed for determining stable monthly income.
A two-year history of receipt is required. However, in certain instances, a shorter history of no less than 12 months documented on the tax returns may be considered stable if the Seller provides a written analysis and sufficient supporting documentation.
Future Income
If borrower is scheduled to begin employment under the terms of an employment offer or contract, there are two options to use income for qualification.
Option 1 -- Paystub Obtained Before Loan Delivery
Executed copy of the borrower's offer or contract for future employment and anticipated income.
Note: The borrower cannot be employed by a family member or by an interested party to the transaction.
Must obtain a paystub from the borrower that includes sufficient information to support the income used to qualify.
Option 2 -- Paystub after Loan Delivery
This option is limited to loans that meet the following criteria:
Purchase of Primary Residence, One-unit property,
Borrower is not employed by a family member or by an interested party to the transaction, and
Borrower is qualified using fixed base income only.
Borrower offer or contract for future employment. The employment offer or contract must:
Clearly identify the employer and the borrower, be signed by the employer, and be accepted and signed by the borrower;
Clearly identify the terms of employment, including position, type and rate of pay, and start date; and
Be non-contingent. Note: If conditions of employment exist, we must confirm prior to closing that all conditions of employment are satisfied either by verbal verification or written documentation.
NEW EMPLOYEE
2-year work history is required.
Exception is if borrower was attending secondary school and graduated with a degree consistent with new employment, or were in a training program related to the new position, immediately prior to their current employment. In other words, your education time is counted as work history.
Evidence to support, such as college transcripts or discharge papers are required to verify.
Second Job
Minimum of two years second job is required.
Exception: If at least 12-months, income may be considered as long as there are positive factors to reasonably offset the shorter income history.
You may have a history that includes different employers, which is acceptable as long as income has been consistently received. In no instance can you have any gap in employment greater than one month in the most recent 12-month period, unless the secondary employment is considered seasonal income.
Temp work (example: traveling nurse)
Base earnings may be considered as qualifying income provided:
Borrower has history of working for a temp agency (minimum of 6 months), and
Borrower can document employment is likely to continue for the foreseeable future.
Recently hired temp workers may be considered provided:
A 2 yr history in same field (prior to going to work for temp agency) can be established, and
No Job gap > 6 months, and
Likeliness of continuance for the foreseeable future can be established, and
Borrower has consistent base earnings since start date.
Paystubs shows You are a W2 earner (payrolls taxes have to be taken out.
Note: Only Base earnings maybe used in qualifying (e.g.: OT, Commission, Bonus, Stipends, Per Diem, Meals, Housing Allowances and other earnings are not allowed in calculation of effective income
Self Employment
Any individual who has a 25% or greater ownership interest in a business is considered to be self-employed.
Factors We Consider
Stability of the borrower’s income,
Location and nature of the borrower’s business,
Demand for the product or service offered by the business,
Financial strength of the business,
Ability of the business to continue generating and distributing sufficient income to enable the borrower to make the payments on the requested mortgage.
Length of Self-Employment
Generally a two-year history of the borrower’s prior earnings as a means of demonstrating the likelihood that the income will continue to be received.
If you have a shorter history of self-employment 12 to 24 months you may be eligible as long as:
Your most recent signed federal income tax returns reflect the receipt of such income as the same (or greater) level in a field that provides the same products or services as the current business or in an occupation in which you had similar responsibilities to those undertaken in connection with the current business.
In such cases, the Underwriter will give careful consideration to the nature of the borrower’s level of experience, and the amount of debt the business has acquired.
Verification of Income
Signed federal income tax returns (both individual returns and in some cases, business returns) that were filed with the IRS for the past 2-years (with all applicable schedules attached).
Alternatively, IRS-issued transcripts of the borrower’s individual and business federal income tax returns that were filed with the IRS for the most recent 2-years—as long as the information provided is complete and legible and the transcripts include the information from all of the applicable schedules.
1-year of personal and business tax returns may be allowed if the following requirements are met:
Business from which the borrower is using self-employed income must have been in existence for 5-years as reflected on the Form 1003, and the borrower has had an ownership share of 25% or more for the past 5-years consecutively, and
for partnerships, S corporations and corporations, the federal income tax return for the business must support the information reflected on the Form 1003. If the business was in existence prior to the borrower having 25% or more ownership, then the lender must demonstrate the borrower has had 25% or more ownership for at least 5-years consecutively.
for sole proprietorships, the individual federal tax return and any other documentation or information received must support the information reflected on the Form 1003 for the number of years the business has been in existence.
All businesses are assessed separately for the five-years in existence benchmark and the number of years of personal and federal income tax returns required could differ when there are multiple self-employment income sources
When two years of signed individual federal tax returns are provided, we may waive the requirement for business tax returns if:
Borrower is using personal funds to pay down payment and closing costs and satisfy applicable reserve requirements,
Borrower has been self-employed in the same business for at least five years (requirements noted above), and
Borrower’s individual tax returns show an increase in self-employment income over the past two years from the respective business.
Use of Business Assets
Borrower intends to use business assets as funds for the down payment, closing costs, and/or financial reserves, we must perform a business cash flow analysis to confirm that the withdrawal of funds for this transaction will not have a negative impact on the business.
In order to assess the impact, the Underwriter may require a level of documentation greater than what is required to evaluate the borrower’s business income (for example, several months of recent business asset statements in order to see cash flow needs and trends over time, or a current balance sheet).
This may be due to the amount of time that has elapsed since the most recent tax return filing, or the Underwriter’s need for information to perform its analysis.
Documents Needed (Basics)
Sole Proprietor
2-Years 1040's, Schedule C or C-EZ.
YTD Profit Loss Statement - (You can create this)
Evidence that the business is active such as current invoices, website, etc.
Partnership
2-Years 1040's, Form 1065
YTD Profit Loss Statement - (You can create this)
S-Corp (state-chartered business)
2-Years 1040's, Form 1120S, K1 1120S Schedule, Part II of 1040 Schedule E.
YTD Profit Loss Statement - (You can create this)
Evidence that the business is active such as website.
Corporation (state-chartered business)
2-Years 1040's.
Corporation pays taxes on Form 1120. Stockholders report on personal 1040.
Evidence that the business is active such as website.
LLC (different potential structures)
One Member: 2-Years 1040's, Schedule C, E, or F.
One Corporate Member: 2-Years 1040's, K-1's and 1120S.
Multiple Members: 2-Years 1040's, K-1's and 1065 returns.
CHANGING FROM W2 TO SELF-EMPLOYED
XXX
Funds for closing
Retirement
Must be buyers funds in account recognized by IRS.
Buyer must be sole owner.
Must have access to withdraw or take loan from.
Funds fully vested.