Section 3.4: Income
Income
3.4-A General Employment and income are essential ingredients to successful home ownership. Qualifying income should be stable, predictable, and likely to continue. The Underwriter must determine that the borrower demonstrates the financial wherewithal to repay the proposed real estate transaction as well as other obligations in addition to having an AUS approval. In determining stable income, underwriters must be able to conclude that the income is likely to continue for the next three years. Declining Income: A two year income stream should be documented and analyzed in each loan file. Both salaried and self employed borrowers should be reviewed for stability of income. Any decline in income must be addressed and the income used to qualify must be justified by the underwriter. Self-employed borrowers: the underwriter must determine if the business can be expected to continue to generate sufficient income for the borrower’s needs. The underwriter must analyze carefully the business’s financial strength, the source of income, and the general economic outlook for similar businesses in the area. Annual earnings that are stable or increasing are acceptable. Conversely, a borrower whose business shows a significant decline in income over the period analyzed is not acceptable, even if current income and debt ratios meet guidelines. Underwriters are encouraged to discuss individual cases with the Regional Operations Manager or Credit Policy Department prior to declining a file for declining income. Increase in income: When the borrower shows a significant increase in income, the higher income may not be used to qualify the borrower, unless there is sufficient documentation to determine that the increase is stable and likely to continue at the level used for qualifying. When evaluating the borrower’s capacity, consider the following factors:
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Payment shock Reserves Income stability Debt ratios History of savings
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February 22, 2011
Section 3.4: Income
3.4-A General (cont’d) 2010 Tax Returns and Self Employed Borrowers All self-employed borrowers will be reviewed on a case by case basis until 2010 4506T transcripts can be obtained. 4506T transcripts from 2008 & 2009 will be required on all loans where the AUS calls for two years tax returns. 4506T transcripts from 2009 will be required on all loans where the AUS calls for one year tax returns. Whenever possible, documentation should be obtained to verify 2010 income. If the borrower’s income is consistent between 2008 & 2009, tax returns for 2010 may not be required. If borrower’s income declined between 2008 & 2009, obtain P&L and 12 months bank statements for review of 2010 income stream to support level income consistent with 2009. (Need to show income has stopped declining). 2010 income will be used as a compensating factor only. If borrower needs 2010 income to qualify, the borrower must provide 2010 tax returns and a validated 4506T transcript for 2010. For borrowers with W-2 income, a copy of the 2010 W-2 must be provided. If the 2010 income/employment is consistent with 2009 income/employment, 2010 income can be used in qualification without the filed tax returns. If 2010 income/employment is significantly higher, and/or has a mix of commission/bonus, which may have 2106 expenses related to the income source, and tax returns are not provided, 2010 income will be used as a compensating factor only. If 2010 income is lower, additional underwriting scrutiny must be given to income acceptability. Loans should be discussed with Regional Operations Managers to determine acceptability of credit risk, based on complete credit profile of transaction and borrower.
3.4-B Documentation Types 3.4-B1 Overview The type of loan documentation used to verify the borrower’s employment and income information in the loan application varies depending on the loan program and program requirements. Not all documentation types can be used on all loan programs. Always refer to the individual loan program and AUS to determine documentation eligibility. Age of credit documents All credit documents in the file cannot be over 60 days old at time of closing. This requirement applies regardless of the credit expiration date on the AUS findings.
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February 22, 2011
Section 3.4: Income
3.4-B Documentation Types (cont’d) 3.4-B2 Verification of Employment and Income Verbal Verifications of Employment requirements for hourly, salary, and commission income A verbal verification of employment is required for all borrowers prior to note date, but no earlier than 3 business days prior to the note date; this requirement applies to all income types with the exception of passive income. Verbal verifications should be completed with the borrower’s human resource, Personnel Department, etc. The completed form must include the following:
Identity of the employer information (company, HR or personnel address, phone number) Name and title of the person at employer who confirmed the employment Source of the phone number (attach copy of source to VOE form) Date of contact. Confirmation that the borrower is currently employed and start date. Signed and dated by the person (name/title) who made contact with the employer
Note: The telephone number used to complete the verbal verification form must be independently obtained through a 3rd party source (411.com, switchboard.com, etc.). If unable to verify phone number through a 3rd party source, return file to underwriting. If the verbal verification is obtained from a third party vendor (The Work Number), the verified date day timeframe is measured from the date of our request to the vendor, not the date the information was updated in the vendor’s database. However, the information must have been updated within the past 35 days. When this verification source is used, the printout is required in lieu of the SNMC Verbal VOE. If borrower is in the military, a military Leave and Earnings Statement (LES) dated within 30 days of closing is acceptable in lieu of the verbal or written VOE. Verbal Verification of Employment requirements for self-employed borrowers The existence of the borrower’s business must be verified within 5 days of funding. SNMC must verify the existence of the borrower’s business within 5 days prior to the closing/funding date from a third party, such as a CPA, regulatory agency, or the applicable licensing bureau, if possible and verify a phone listing and address for the borrower’s business using a telephone book, the Internet, or directory assistance. If contact is made verbally, SNMC must document the source of the information obtained and the name and title of our employee who obtained the information. This policy applies to both conventional and government loan programs (except non-credit qualifying FHA Streamline refinances). Standard Verification of Employment (VOE) Must be sent to and returned from the borrower’s employer directly. The borrower or any other 3rd party should not be involved in this process. VOE should be supported by a paystub in file.
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February 22, 2011
Section 3.4: Income
3.4-B Documentation Types (cont’d) 3.4-B2 Verification of Employment and Income (cont’d) Paystubs Paystubs must be computer generated or typed; not handwritten. Identify the employer Identify borrower as an employee Time period covered Provide year to date earnings Must cover minimum 30 days of earnings W-2/1099 Statements Most recent two years of statements Identify employer Identify borrower as an employee Any above documents used must meet the following minimum requirements Complete and Legible copies of the original documents The original documents must not contain any alterations, erasures, correction fluid, or correction tape Electronic, Faxed, or Computer Generated o The source of the information must be clearly identified (Internet or fax banner at top) o An acceptable verifier must provide documentation o Documents must clearly identify the name of the employer
3.4-C Automated Underwriting Requirements SNMC will not allow any AUS income documentation waivers that do not require at a minimum the following information:
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Verbal Verification of Employment Most recent paystub Previous year W-2 statement Previous year tax return, if applicable
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February 22, 2011
Section 3.4: Income
3.4-D 4506T The following number of years of IRS 1040 transcripts will be required in each loan file. The first column reflects the file documentation and/or AUS requirement, and the second column reflects the number of years of IRS 1040 transcripts required.** AUS Requirement Transcripts Required YTD pay stub and one W-2 One year YTD pay stub and two W-2’s Two years Personal returns (1040s) for one year One year Personal returns (1040s) for two years Two years Personal and business returns for two years* Two years * When multiple tax returns are used (ex. 1040, 1120, 1065, etc.), the borrower’s personal tax returns at a minimum, must be validated. **Additional transcripts may be required if you cannot validate the current year with current transcripts. For example if your AUS requires a YTD pay stub and one W-2, and the W-2 is for 2009, but you cannot validate the 2009 1040, you would need to get the 2008 W-2 and validate it with 2008 transcript in order to meet you one year requirement. The same would apply for the two year validation requirement. You must always be able to validate with transcripts the number of years in column 2. All loans delivered to the investor must have the 2009 Tax Transcripts for all borrowers and loan products. Note: If an AUS response requests more than the most recent tax transcript or if more than one year tax returns is required for underwriting purposes, the additional tax transcripts are required. Comparing Income Documentation to Transcripts The underwriter should compare the W-2, paystubs, Written VOE, tax returns, etc. to the sections as shown on the IRS transcripts for the corresponding years. The following variance guidelines apply:
If the IRS transcripts show earnings 0% to 10% greater that the income documentation, the documentation is acceptable. If the IRS transcripts show earnings greater than 10%, the underwriter should address the discrepancy and document the file accordingly. Examples of when this might occur include: o o
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Wage earning spouse who is not on the transaction Borrower who has an additional wage-earning job not disclosed.
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February 22, 2011
Section 3.4: Income
3.4-D 4506T (cont’d) Business Loss from Non-Borrowing Spouse In regards to the treatment of business loss from a non-borrowing spouse reflected on tax transcripts the issues are twofold. First to determine and document that our borrower does not have an interest in the business in question, and second to determine what impact the business loss will have on the household income, and how that will affect the performance of our mortgage. If the underwriter feels documentation can be provided to address these two issues, exceptions will be considered to not count the loss. Exceptions should be presented and approved through Regional Operations Manager. Documentation must address the following:
Proof the borrower does not have any interest in the business in question. This could be accomplished by providing a business license, if available, or evidence of the SS# associated with business documentation. Analysis to support the business loss is not materially significant to the household income, and will not impact the ability of the borrower to make the mortgage payment.
3.4-E Acceptable Income Sources 3.4-E1 Alimony / Child Support / Separate Maintenance In order for alimony or child support to be considered as stable income, the borrower must have received income for at least 12 months and it must continue for at least three years as specified by the court order, divorce decree, or an attorney’s letter specifying the individuals and children. When a borrower has been receiving full or partial payments for alimony or child support or maintenance on an inconsistent or sporadic basis, the income may not be considered as stable income or be used to justify a higher qualifying ratio. If a borrower who is separated does not have a legal separation agreement that specifies alimony or child support payments, the underwriter should not consider any proposed or voluntary payments as income when qualifying the borrower. Alimony is taxable and reflected on page one of the borrower’s personal tax return. Child support is taxexempt and therefore can be grossed up. Documentation for alimony, child support, and/or household maintenance income is not required if the borrower does not use the income to qualify. Conventional loans only: If the income is received for 6-12 months, the income may be considered stable but must not consist of more than 30% of the total qualifying income. Verify that income has been received for the past three consecutive months. If income is received less than six months, income may only be used as a compensating factor.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E2 Automobile and Housing Allowances Automobile allowances can be used as acceptable stable income for a borrower who has been receiving the payments for at least two years, provided the underwriter includes all associated business expenditures in the calculation of the borrower’s total debt-to-income ratio. If the borrower has been receiving payments for less than two years, the income can only be used as a compensating factor. Typically, automobile allowance is included with the W-2 earnings, therefore it is very important to make certain the income is not included twice. This information must also be included in an analysis developed from the IRS Form 2106. Acceptable documentation can be written VOE covering two full years, most recent year to date paystubs covering at least 30 days of employment, or W-2s covering the most recent two years. If the allowance is not reflected on the VOE, additional documentation must be obtained by the employer. The documentation provided must specify the following information:
Payment amount Duration and Frequency Likelihood of continuing for the next three years
3.4-E3 Bonus Bonus income can be used to qualify the borrower if the employer verifies that the borrower has received it for the past two years and indicates that the bonus income will in all probability continue. This can be verified with a VOE (Form 1005). The nature of the bonus must be determined up front in order to include in the qualifying income. The underwriter should also take into consideration the consistency with which the borrower received bonus income. Bonuses that are received annually or on another periodic basis are acceptable, even if the amount of the bonus fluctuates. The underwriter must look at an average of the last two years, the last year and YTD to determine the most conservative qualifying figure that can be used. Enter this amount into the automated system separately from the base income. Projected bonus is not an acceptable source of income.
3.4-E4 Commissioned Borrowers If the borrower does not have a history of receiving commission income for at least 2 years, it is an exception to policy and will only be considered on a case-by-case basis. If the borrower changes employers, their income cannot necessarily be based on past commissions. The income must be likely to continue for the next three years. Income may be subject to fluctuations from year to year. If there are large fluctuations, the borrower must provide a written explanation to support the increase in income and the appropriate adjustments made to average income used to qualify. The Underwriter should review a two year average, the last year average and YTD average to determine the most conservative amount of qualifying income that can be used. If the trend for the commission earnings shows a decline, they should not be considered as stable income. When calculating the borrower’s annual income, any non-reimbursed business expenses (2106, found on Schedule A) must be subtracted from the gross commission income. If commission income represents 25% or more of the salaried borrower’s income, complete signed tax returns will be required. If the commission income represents less than 25% of the borrower’s total income, the standard salaried borrower income documentation is allowed. IRS transcripts should be reviewed for non-reimbursed business expenses.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E5 Disability Income or Workman’s Compensation Permanent disability benefit payments should be treated as acceptable stable income unless the terms of the disability policy specifically limit the stability or continuity of the benefit payments. Benefits that have a defined expiration date must have a remaining term of at least three years from the closing date in order to be used to qualify the borrower. For example, if a borrower is receiving disability benefits that are scheduled to be discontinued when he or she reaches a certain age and the borrower will reach that age within 3 years of loan closing, the underwriter should not count the disability income. The underwriter should review the policy or benefits statement to verify the amount of disability payments and to determine whether there is a contractually established termination or modification date. Disability pay may come from public or private companies. Conforming: Temporary Disability income may be used if properly documented in the form of award letters and verification from payer of disability income and letter from the borrower and employer. There is no restriction on the length of time the income has been received. There should be reasonable likelihood the income level will continue for at least three years after the disability payments cease. The documentation must clearly show:
Borrower’s total income is stable and level AND Payment amount and conditions for termination of payment AND The most recent check copy or bank statement is required if the award letter does not contain the current payment being received AND Letter from the borrower on temporary disability, clearly stating that he fully intends to return to work once the disability no longer exists. If possible, obtain a copy of the doctor’s notice showing the date that the borrower will return to work AND Letter/verification from the employer stating that the borrower will be allowed to return to work once the disability no longer exists. The letter must identify the borrower’s position and rate of pay upon return. If the future employment income will be less than the disability income, the lower income amount must be used to qualify for the loan.
FHA/VA: Temporary Disability not eligible
3.4-E6 Employed by Relatives/or Related Party to the Transaction If borrowers are employed by a relative, domestic partner, fiancé/fiancée, or family business, property seller, or real estate broker, signed copies of the borrower’s most recent two years tax returns are required for verification of income, regardless of AUS findings.
3.4-E7 Foster Care Income Income from a state or county sponsored organization may be considered if there is a 2-year history of providing foster care services, and it is likely to continue at a level that supports the amount of income needed for qualifying for the next three years. This income may be verified by letters from the organizations and copies of borrower’s deposit slips or bank statements showing regular deposit of the payments. Income for children who will reach the age of 19 within three years will not be considered.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E8 Frequent Job Changes (cont’d) Although borrowers who frequently change their jobs do not necessarily pose a greater credit risk, there may be occasions that warrant a closer examination of employment and income. Example: Frequent changes in employment for reasons other than advancement (i.e. changing careers) or extended periods of unemployment may be indicative of an unsteady work history and income. Borrowers with questionable employment histories must have financial strengths in order to be considered for financing. Borrowers who work in certain industries may experience frequent job changes due to the nature of the work (i.e. seasonal or unskilled labor). In these instances, borrowers should not be penalized provided they have demonstrated the ability to maintain a steady income despite the changes.
3.4-B9 Gap in Employment A thorough review of a borrower’s employment history is required. Multiple job gaps or frequent changes in employment in the past 24 months should be carefully reviewed by the underwriter to determine if the borrower’s employment is stable and likely to continue. In addition, if the borrowers have been employed less than two years but were previously in school or in the military, the Underwriter must obtain a copy of diploma or discharge papers. No gaps of verified employment income may exist for self-employed borrowers. Conventional loans: Any gaps in employment over one month in the past two years must be satisfactorily explained by the borrowers. If the borrower is re-entering the workforce, obtain documentation that the borrower has been at the current employment for a minimum of six months and documentation to show a previous work history. FHA loans: Any gaps in employment over one month for a manual underwrite, or six months with Total Approval, in the past two years must be satisfactorily explained by the borrowers. The written explanation, including the reasons for the gaps, must be included in the loan file. For more information in regarding borrowers return to work after an extended absence, see the 4155.1 Chapter 4.D.1.d. Extended absence is defined as six months to remain constant with Total.
3.4-E10 Interest and Dividend Income Interest and dividend income may be used as acceptable stable income if it is properly documented and has been received for the past two years and it is expected to continue to be received for a minimum of three years from the date of the mortgage application. The Underwriter must look at an average of the last two years, the last year, YTD and current rate, etc. (if applicable) to determine the most conservative qualifying figure that can be used. The underwriter must verify the borrower’s ownership of the assets on which the interest and/or dividend income is being earned. Any assets used for down payment or closing costs must be subtracted from the borrower’s total assets before calculating expected future interest or dividend income. Proof of sufficient assets to generate dividend and interest income after closing must be documented for income to be expected to continue for three years.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E11 Military Income Military personnel may be entitled to different types of pay in addition to their base pay. Flight or hazard pay, rations, clothing allowance, housing allowance, and proficiency pay are acceptable sources of stable income, as long as the underwriter can establish that the particular source of income will continue to be received for at least three years. Income paid to military reservists while they are fulfilling their reserve obligations is also acceptable if it satisfies the same stability and continuity tests that are applied to second-job income. Education benefits may not be used to calculate qualifying income. Obtain a copy of the borrower’s last Leave and Earnings Statement (LES) to verify allotments, allowances, estimated time in service, and the amount of gross pay. Also, obtain and verify the following from the LES:
Military rank Social security number Military address Length of active service to date Estimated remaining time at present location
3.4-E12 Military / VA Benefits Borrowers receiving VA benefits can use the income with proof the benefits will continue for at least three years from the date of loan application. Education benefits may not be used to calculate qualifying income because they are offset by educational expenses.
3.4-E13 Notes Receivable Payments on notes receivable must continue for at least three years from the date of the mortgage application in order to be considered as acceptable and stable income. A copy of the note must be provided to establish the amount and length of payment. The borrower must provide evidence that they have received the funds for the last 12 months. Acceptable evidence includes deposit slips, copies of signed federal income tax returns that were filed with the IRS, or copies of the borrower’s bank statements that show consistent deposits of these funds. Payments on a newly executed note that specifies a minimum duration of three years may not be used as stable income, but may be used as a compensating factor to allow higher ratios.
3.4-E14 Overtime If overtime is considered in the income calculation, it must be verified and substantiated by the borrower’s previous 2 years earnings. The underwriter must look at an average of the last two years, the last year, and YTD to determine the most conservative qualifying figure that can be used. However, if the trend for the overtime earnings shows a decline, it will not be considered as stable. Projected overtime is not an acceptable source of income. Enter the amount into the automated system separately from the base income.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E14 Overtime (cont’d) The employer must verify that overtime income is likely to continue. This can be verified on company letterhead or with a written VOE. If the employer refuses to provide this information, the loan file and the underwriter’s analysis must be explicit regarding the inability to obtain this information and the underwriter must provide supporting rationale as to why this income is included and expected to continue.
3.4-E15 Part-Time, Second Job, or Multiple Job Income Part-time, second job, or multiple job income may be considered as stable income if it can be verified as having been uninterrupted for the previous two years and has a strong likelihood of continuation. Verification of a part-time or second-job income must be supported by IRS W-2 forms and a recent pay stub. Borrowers with a 12-24 month history will be an exception to policy and will be considered on a case-bycase basis. The work must either be entry level (for example, fast food or entry level clerical) or related to the borrower’s primary employment (for example, a policemen doing security work). There must be a strong likelihood of the income to continue in order for the exception to be considered. Generally, an average of income should be used to qualify. The Underwriter should review a two year average, the last year average and YTD average to determine the most conservative amount of qualifying income that can be used.
3.4-E16 Projected income – New Job Borrowers must be able to provide a pay stub with at least 30 days of YTD earning from their current employer. Loans with pending employment contracts (for example, teachers with a contract for the upcoming school year that has not started), offer letters or employment that has not resulted in a pay stub with at least 30 days of YTD earnings are not eligible for AUS approval.
3.4-E17 Rental Income Rental income is documented by the borrower’s individual tax returns on Schedule E. The underwriter should request the most recent two years federal tax returns and current lease agreement as evidence of the receipt of rental income. Depreciation can be added back to the net income or loss shown on Schedule E. Unallowable losses should be deducted from the net income that is shown on Schedule E and any loss carryovers from previous years should be added to the net income. Positive net rental income may be entered in as Gross Monthly Income. Aggregate net rental loss must be included as a liability. When the rental income relates to the subject property and the borrower has no history of receiving rental income from the property, an appraiser’s opinion of market rent and, if applicable, copies of the current lease agreement(s) are required. The lesser of the appraiser’s opinion of market rent or the lease agreements must be used. Net rental income will equal 75% of the gross rent. When the borrower has a history of receiving rental income for the subject property, the rental cash flow should be analyzed.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E17 Rental Income (cont’d) When the rental income relates to the rental property other than the subject property, rental income may be documented by obtaining copies of the borrowers most recent two years signed tax returns. Current lease agreements may only be used if a property was not listed on Schedule “E” because it was acquired subsequent to filing the tax return. If using the current lease agreements, use the net rental income of 75% of the gross rent from the lease agreements. Conforming: If Subject is Investment Property: The borrower must have a two-year history of managing rental properties. Verification must be provided through the most current two years signed tax returns. Exception: the two year history managing rental properties may be waived if the loan meets one of the following requirements and loan has a DU approval.
The borrower qualifies for the mortgage based on the full PII for the subject property without having to rely on the rental income OR Purchase or rate term refinance with an LTV less than or equal to 75% OR Cash out refinance with an LTV less than or equal to 70%
Rent Loss Insurance Borrowers using rental income to qualify must obtain rent loss insurance for 1-4 investment properties and 2-4 unit owner-occupied properties. Rent loss insurance covers rent losses incurred following a casualty for a minimum of six months during the rehabilitation of property. As not all automated underwriting systems may not be updated to condition for this requirement, underwriter must manually apply this guideline.
3.4-E18 Rental/Conversion of Primary Residence in to a Rental Borrowers who currently own their home typically have three options when they decide to purchase a new principal residence:
They can sell the current residence and pay off the outstanding mortgage, Convert the property to a second home, assuming they can qualify with both the existing and new mortgage payments, and the property meets second home parameters, or Convert the property to an investment property and provide documentation that they will rent the property and use the income to offset the mortgage payment
In order to ensure that borrowers have sufficient equity and/or reserves to support both the existing financing and the new mortgage being originated, the following policy has been established for borrowers purchasing a new principal residence and converting their existing principal residence to an investment property.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E18 Rental/Conversion of Primary Residence in to a Rental (cont’d) Conventional loans: FNMA: SNMC will continue to permit 75% of the rental income to be used to offset the mortgage payment in qualifying if there is documented equity of at least 30% in the existing property (derived from an appraisal or AVM minus outstanding liens). The rental income must be documented with: A copy of the fully executed lease agreement. The underwriter must insure that the amount of the lease is typical for the market, and The receipt of a security deposit from the tenant and deposit into the borrower’s account FHLMC: FHLMC has revised the minimum reserve requirement when converting a primary residence to any of the following:
Pending Sale Investment property Second home
The revised guideline is applicable with all loans using Loan Prospector and is as follows:
If the LTV ratio for the property that is pending sale or being converted is >70%: o 6 months PITI required for the property pending sale or being converted and 6 months PITI required for the new primary residence. If the LTV ratio for the property that is pending sale or being converted is <70%: o 2 months PITI required for the property pending sale or being converted and 2 months PITI required for the new primary residence
The value on the property being converted must be documented by obtaining a new appraisal with at least and exterior only inspection date no more than 60 days prior to the note date. The above reserve requirements are the minimum required for the above scenarios, specific program or AUS findings may require additional reserves. Any loan sent to investor for prior approval with DU or LP findings, will need to follow the above policy. FHLMC Rental Income Reminder: If the borrower’s tax returns reflect a two year history of managing renal properties, 75% of the rental income may be used to offset the mortgage payment in qualifying if all of the following items are met:
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Copies of most recent two year filed and signed tax returns reflecting a history of managing rental properties The LTV/TLC VT/HTLTV of the property being converted must be less than or equal to 70% as evidence by an appraisal with at least an exterior only inspection dated no more than 60 days prior to the note date. A fully executed copy of the lease and receipt of the security deposit from the tenant with evidence of the deposit in to the borrower’s account
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E18 Rental/Conversion of Primary Residence in to a Rental (cont’d) This is not a change to FHLMC guidelines; FHLMC requires a two year history of managing rental properties to use rental income for qualifying purposes. If the 30 percent equity in the property cannot be documented, rental income may not be used to offset the mortgage payment.
The full PITI payments for both the current and the proposed mortgage must be used to qualify the borrower for the new transaction, and 6 months of PITI for both properties is required to be in reserves
FHA loans: SNMC will permit the current rental income, reduced by the appropriate vacancy factor as determined by the jurisdictional FHA HOC, to be used to offset the mortgage payment in qualifying if:
There is documented equity of at least 25% in the existing property (derived from a minimum of a drive by appraisal, form 2055) The borrower is relocating with a new employer, or being transferred by the current employer to an area not within reasonable and locally-recognized commuting distance.
The rental income must be documented with A copy of the fully executed lease agreement. The underwriter must insure that the amount of the lease is typical for the market and The receipt of a security deposit from the tenant and deposit into the borrower’s account If the equity position or relocation conditions cannot be met the borrower must be qualified using the full PITI payments on both the current and proposed residence. VA loans: Obtain a copy of the rental agreement on the property, if any. Use the prospective rental income only to offset the mortgage payment on the rental property and only if there is no indication that the property will be difficult to rent. This rental income may not be included in effective income. Obtain a working knowledge of the local rental market. If there is no lease on the property, but the local rental market is very strong, the lender may still consider the prospective rental income for offset purposes. Income from roommates in a single family property occupied as the borrower’s primary residence is not acceptable for either conventional or FHA loans. Boarder income can be used for FHA loans provided the boarders are related by blood, marriage or law. The rental income may be considered effective only if shown on the borrower’s tax return. If not on the tax return, rental income paid by the boarder may only be considered a compensating factor and must be adequately documented by the lender. Boarder income cannot be used for conventional loans. Underwriting analysis on VA loans may not consider rental income from the property vacated except under the circumstances described below: Exceptions: Rental income on the property vacated reduced by the appropriate VA vacancy factor (25%) may be used under the following circumstances:
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E18 Rental/Conversion of Primary Residence in to a Rental (cont’d) Relocations: The homebuyer is relocating with a new employer, or is transferred by the current employer to an area not within a reasonable and locally recognized commuting distance. A properly executed lease agreement (a lease signed by the homebuyer and lessee) of at least one year’s duration is required from the date the loan closes. You may also want to obtain evidence of the security deposit and/or evidence the first month’s rent was paid to the homeowner. Sufficient Equity in Vacated Property: The homebuyer has a loan-to-value ratio of 75% or less, as determined by either a current (no more than six months old) residential appraisal or by comparing the unpaid principal balance to the original sales price of the property. The appraisal, in addition to using Form 1004-70, may also be an exterior only appraisal using Form 2055 and for a condo, Form 1075-466. The above guidelines apply solely to a primary residence vacated in favor of another primary residence and are not applicable to existing rental properties disclosed on the loan application and confirmed by tax returns (Schedule E).
3.4-E19 Retirement Income or Distributions Retirement or pension income is an acceptable source of stable income as long as the borrower’s regular receipt of the payments is confirmed. Retirement income may be verified by letters from the organizations providing the income, copies of retirement award letters, copies of signed federal income tax returns that were filed with the IRS, IRS W-2 forms, or copies of the borrower’s twelve most recent bank statements. AUS findings may be less restrictive regarding the months of bank statements required. When the retirement income is received in the form of a monthly annuity payment, a statement from the financial institution managing the annuity is required to verify the balance of the annuity, the monthly payments, or term of the payments to be distributed. Payments to the borrower must continue for a minimum of three years. Regular distribution from a 401K, IRA, or Keough retirement account may be used as qualification income provided the distributions will continue for a minimum of three years. A letter from the administrator of the account is required to verify the terms of the distributions and document the receipt of the funds and the current balance of the account. The underwriter must determine that the income is expected to continue to be received for at least three years after the date of the mortgage application.
3.4-E20 Seasonal Income Seasonal part-time or second job income (including seasonal unemployment compensation) can be considered as stable income if the borrower has worked in the same job or line of seasonal work for the past two years and the borrower’s employer indicated that there is a reasonable expectation that the borrower will be rehired for next season. Examples of borrowers who have seasonal jobs include outdoor laborers, income tax preparers, supplemental department store personnel, etc. The underwriter should not use seasonal unemployment compensation to qualify the borrower unless it is appropriately documented, clearly associated with seasonal layoffs, expected to recur, and reported on the borrower’s federal income tax returns.
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February 22, 2011
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3.4-E Acceptable Income Sources (cont’d) 3.4-E21 Social Security Income Social security benefits that have defined expiration dates must have a remaining term of at least three years from the date of the mortgage application to be considered as acceptable stable income. Acceptable verification of social security income includes a copy of the Social Security Administration’s award letter, copies of signed federal income tax returns that were filed with the IRS, IRS W-2 forms, or copies of the borrower’s recent bank statements. Social Security may or may not be taxable. Review tax returns before grossing up income to make sure it is not taxable. If income is verified as non-taxable, it can be grossed up 25% for qualifying purposes.
3.4-E22 Tax-Exempt Income The underwriter may gross up all tax-exempt income by 25% once it has been established that such income is non-taxable, likely to continue and remain untaxed into the foreseeable future. Examples of such income include certain military allowances and veterans’ benefits; child support payments; some social security benefits; workers’ compensation benefits; disability retirement payments; certain types of insurance benefits; clergy housing allowances; foster care income; and income from municipal bonds (generally exempt from federal taxes only). VA: Gross income up for ratios only not for residual
3.4-E23 Tip Income Tip income may be used to qualify providing the borrower has received it for the last two years and the employer indicates that the tip income will in all probability continue. The underwriter must look at an average of the last two years, the last year and YTD income to determine the most conservative qualifying figure that can be used. If the tip income is not reported on the paystub or income tax returns it may not be used for qualifying or as a compensating factor.
3.4-E24 Trust Income Trust income may be used provided the trust is irrevocable, a statement is obtained from the trustee stating the amount, frequency, duration of the income, and there is a minimum 24 month history of receipt. The income must continue for at least three years. A copy of the trust agreement should be provided. Letters from attorneys, accountants, or trust companies may be acceptable in lieu of a copy of the agreement if the trust income is not a substantial portion of the qualifying income. Acceptable documentation includes the verification of sufficient trust assets to maintain the income for at least 36 months from the loan application date. Borrowers substantially or totally relying upon trust income for the mortgage repayment must provide copies of the trust agreement and the most recent preceding 1 year signed, dated tax return, with supporting schedules.
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February 22, 2011
Section 3.4: Income
3.4-E Acceptable Income Sources (cont’d) 3.4-E25 Unemployment Income Compensation from unemployment income may be considered if it is common and customary for the line of work and if the borrower has a 2-year history of receiving income from both a seasonal job and unemployment compensation. The amount, frequency, and duration must be stated in the documentation and be likely to continue for the next three years. In addition, there must be reasonable expectation that the borrower will be rehired the next season. If the borrower is a seasonal worker, proof of current receipt of unemployment cannot be substituted for a current paystub to satisfy the AUS requirements. The paystub must be from the borrower’s regular employment.
3.4-E26 Union Workers Union workers are members of a specific trade union and are often skilled tradesperson (i.e. electricians, plumbers, roofers, etc). Workers can work for a single employer on a long-term basis or for more than one employer throughout the year. At the completion of a job, the Union will then refer the individual to a new employer. During the individual’s course of employment with the assigned employer, they are paid directly by the employer, not the Union. Their jobs may be seasonal and it is not uncommon for individuals to receive unemployment during down time. Verify that the borrower is a member of the Union and in good standing. It is not necessary to verify Union dues or count them as a liability. If the borrower is a member of a local trade union and obtains employment via these means, income can be verified by the following:
2 years tax returns and YTD pay stubs 2 years of W-2’s and YTD pay stubs A VOE from the Union for earnings from all employers during the current year and W-2s from the prior 2 years
Note: This policy does not apply to borrowers who are employed by a traditional employer (i.e. GM, Ford, etc.), but rather are members of a trade union such as a carpenters union. Borrowers who are employed by a traditional employer would be considered wage-earner employees.
3.4-E27 Wage Earner Income Wage earners are all non-self-employed borrowers who receive a W-2 at year end to summarize total earnings – including hourly, weekly, biweekly, part-time, seasonal, bonus, commission, and tips/gratuity. This will also include deferred income. A 2-year employment history must be reflected on the application and verified in the loan file. Pay stubs, W-2s, and tax returns are valid forms of documentation. The payment period: weekly, biweekly, or monthly must be well defined by the pay stub(s). There must be at least 30 days of YTD earnings shown on the pay stubs.
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February 22, 2011
Section 3.4: Income
3.4-F Unacceptable Sources of Income
Foreign income Income based on future earnings Draw income VA Education benefits Income from Mortgage Credit Certificates Illegal income Taxable Income not listed on tax returns Lump sum payments such as inheritances or lawsuit settlements Unverifiable income Value of employment benefit packages that are not received as cash wages Lump sum payments of lottery winnings that are not ongoing Student loans/grants Trailing wage earner income
3.4-G Self Employment 3.4-G1 Overview A borrower is considered self-employed if:
They own 25% or more of a business They are filing a Schedule C as the owner of a sole-proprietorship Their salary is commission based and they file as self-employed on their tax returns They receive a 1099 from their employer to document income
Employment and Income History The borrower must be self-employed for at least two years at the same business in the same location. If the borrower has changed locations, it is an exception to policy and will only be considered on a caseby-case basis. A borrower who has been self employed for less than two years is not eligible. A steady decrease in the business’ income for the previous two or three years is not acceptable even if the borrowers’ current ratios conform to program requirements. Any declining income from selfemployment will require a second signature from Credit Policy or Regional Operations Manager. Particular attention should be placed on the business’ earnings trend to ensure income is steady or increasing, and to the source of that income. Even if income from the self employed borrower’s business is not used for qualification purposes, the business must still be analyzed to ensure that it will not affect the borrower’s personal income or assets negatively. An analysis of the borrower’s experience, income stability, financial strength of the business, location and nature of the business, and demand for the service or product offered by the business should be performed. Certain occupations/business may be considered higher risk and should be treated with additional caution.
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February 22, 2011
Section 3.4: Income
3.4-G Self Employment (cont’d) 3.4-G2 Types of Self-Employment Sole Proprietorships This is one of the riskier business classifications due to the owner’s unlimited personal liability for business debt and losses. The underwriter should review the tax returns to make certain there is sufficient and stable cash flow to support both the business and the payments for the requested mortgage. The underwriter should also determine whether the business can accommodate the withdrawal of assets or revenues should the borrower need them to pay the mortgage payment or other personal expenses. Partnership This is an arrangement between two or more individuals who have pooled their assets and skills to form a business and who will share profits and losses (according to predetermined proportions that are set out in the partnership agreement). A partnership may be a general partnership or a limited partnership. General Partnership Under a general partnership, each partner has responsibility for running the business, is personally liable for the debts of the entire business, and is responsible for the actions of every other partner (unless otherwise specified in the partnership agreements). The partnership must report its profit or loss on the U.S. Partnership Return of Income (IRS Form 1065) and each partner’s share of the profit or loss on the K-1; however the partnership pays no tax on the partnership income. Each partner uses the information from the K-1 to report his or her share of the partnership’s net profit or loss. Individual partners pay taxes on their proportionate share of the net partnership income at their individual tax rates. Because profits may or may not be distributed to the individual partners, the underwriter should determine if the borrower actually received a distribution from the partnership. To quantify the level of the borrower’s financial risk, the underwriter should determine whether the borrower has guaranteed any loans obtained by the partnership (other than loans that are considered as non-recourse debt or qualified non-recourse debt). Limited Partnership Under a limited partnership, a limited partner has limited liability based on the amount he or she invested in the partnership, does not typically participate in the management and operation of the business, and has limited decision-making ability. A limited partnership will have at least one general partner who manages the business and is personally liable for the debts of the business. Individual partners pay taxes on their proportionate share of the net partnership income at their individual tax rates. Because profits may or may not be distributed to the individual partners, the underwriter should determine if the borrower actually received a cash distribution from the partnership. However, because limited partnerships are often formed as tax shelters, it is more likely that the K-1 will reflect a loss instead of income. In such cases, the borrower’s ability to deduct the loss will be limited by the “at risk” amount of his or her limited partnership interest. To quantify the level of the borrower’s financial risk, the underwriter should determine whether the borrower has guaranteed any loans obtained by the limited partnership (other than loans that are considered as non-recourse debt or qualified non-recourse debt).
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February 22, 2011
Section 3.4: Income
3.4-G Self Employment 3.4-G2 Types of Self-Employment (cont’d) Corporation This is chartered by a state that gives it legal rights as an entity, separate from its owners. This form of business is characterized by limited liability of its owners. Ownership is in the form of shares. An S-Corporation (also known as a Subchapter S Corporation) is the form of corporation with fewer than 75 shareholders. It enables the company to have the benefits of incorporation, but be taxed as if it were a partnership
3.4-G3 Self-Employment Documentation Requirements SNMC requires the most current two years tax returns when calculating income for a self employed borrower. This applies even though the borrower is not required to file tax returns until April 15th. A prudent loan decision cannot be made with income documentation that is over 12 months old. An acceptable alternative to the most recent tax return would be an audited P&L, which could be considered on a case by case basis. A detailed income analysis must be prepared by the Underwriter and included in the loan file. As there are different forms of self-employment, there are different methods of documentation for this income. In all cases you will request the borrower’s individual Federal tax returns (IRS form 1040s). Individual state tax returns are never required. To document a sole proprietorship, obtain the borrower’s complete, and most recent 2 years federal income tax return (IRS form 1040s). Income will be derived from the Schedule C while farm income is derived from Schedule F. To document a Partnership, General or Limited, obtain the borrower’s most recent two years individual tax returns (IRS form 1040s) and U.S. Partnership Returns (IRS form 1065s). The income will be derived from Schedule E. This is accompanied with the borrower’s K-1 which will show his or her percentage of ownership. To document a Corporation obtain the borrower’s most recent two years individual tax returns (IRS form 1040s), W-2s (when they are an officer of the corporation), and U.S. Corporation income tax return (IRS form 1120s). To document an S Corporation, obtain the borrower’s most recent two years individual tax returns (IRS form 1040s), W-2s (when they are an officer of the corporation), and U.S. Corporation income tax return (IRS form 1120S). Evidence is required to document that the business is currently in existence. If a business requires a business license to operate, a copy of the current business license is preferred. If a business license is not required, other evidence or documentation may be provided from a third party, such as a signed statement from the borrowers CPA, verbal verification with a local or state business regulatory agency or trade organization.
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February 22, 2011
Section 3.4: Income
3.4-G Self Employment (cont’d) 3.4-G3 Self-Employment Documentation Requirements (cont’d) Income Analysis It is highly recommended that Underwriters use the Cash Flow Analysis form 1084 published by FNMA that can be found in Credit Policy to determine qualifying income (Schedule Analysis method). The completed form, including the average monthly income developed by the underwriter, should be included in the loan file. If this form is not used, full details of how the income was derived should be documented on the 1003, 1008, or on a separate page. The use of the outdated Adjusted Gross Income method form is strongly discouraged. Use the borrowers’ signed federal tax returns from the previous two years to determine an average monthly income. For self-employed borrowers to qualify for the loan, the Underwriter should be able to confirm the financial strength of the business, and that it will continue to generate the necessary income. Income that shows a steady decrease for the previous two or three years is generally not acceptable, even if current ratios conform to program requirements. Projected Income Projected income may not be used for qualifying purposes
3.4-G4 Schedule Analysis Method Schedule C (Profit or Loss from Business): Used to determine the business income for sole proprietorship. For conventional loans depletion and depreciation, expenses for business use of the borrower’s home and amortization can be added back. For FHA loans only depreciation and depletion can be added back. The 50% meals and entertainment exclusion should be deducted from the net income or loss to determine actual income. Schedule D (Capital Gains and Losses): Capital gains or losses that are one-time transactions should not be considered in determining income. Only recurring gains and losses consistent over a period of time may be considered in the income analysis. Borrower must have sufficient remaining like assets. If the capital gains represent a large portion of income, the underwriter should use three-years’ signed tax returns. In addition, the underwriter should determine if the asset sold will have an adverse affect on future income. FHA loans require three year tax returns in all cases. Schedule E (Supplemental Income or Losses): Income or loss is taken from Schedule K-1 of the U.S. Partnership Return of Income (IRS Form 1065). If the business is a partnership, the income or loss is the sum of ordinary income (or loss) and guaranteed payments. If the business is an S corporation, the income or loss is the sum of ordinary income (or loss) and other income (or loss). Any income from rental properties or royalties may be used as income after adding back any depreciation providing continuance can be established. Schedule F (Farm Income and Expenses): Used to determine business income from farming. To determine available income, depreciation may be added back to the net profit or loss. Schedule F income on the subject property may indicate the property is ineligible as a income producing property. Form 2106 (Employee Business Expenses): Used when a borrower has business expenses required in the performance of their employment. Business expenses actually paid by the borrowers should be deducted from available income.
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February 22, 2011
Section 3.4: Income
3.4-G Self Employment (cont’d) 3.4-G4 Schedule Analysis Method (cont’d) W-2 (Wages and Tax Statement): Used to verify income of a borrower receiving wages from a Corporation or S Corporation, when he or she is an officer of the corporation. Used to determine the self-employment income and financial status
3.4-G5 Calculating Allowable Corporate Income Introduction Before adding after-tax corporate earnings to borrowers’ income for qualification purposes, the borrowers’ percentage of ownership and right to the funds must be verified. IRS Form 1120 (U.S. Corporation Income Tax Returns) and the Self-Employed Income Analysis are used for this purpose. Percentage of Ownership The borrowers’ percentage of ownership in the corporation is usually found in the "compensation of officers" section of the corporate tax returns. If this information is not provided on the tax return, a letter from a corporation’s accountant or other evidence of the borrowers’ ownership must be obtained. Share in Corporate Profits The borrowers’ portion of the corporation’s after tax profits can be used for qualification only if the borrower owns 100% of the corporation. Fiscal versus Calendar Year If the corporation operates on a fiscal year that is different from the January through December calendar year, adjustments must be made to relate the corporate income to the borrowers’ individual tax return. This information is reflected directly under the title "U.S. Corporation Income Tax Return" on the Form 1120. Analyzing the Corporate Return When reviewing IRS Form 1120 to determine the adjusted business income, underwriters should pay particular attention to the following items:
Taxable income: Must be reduced by the corporation’s total taxes to determine after tax income. Depreciation: Must be added back to the corporation’s after-tax income Depletion: Must be added back to the corporation’s after-tax income
Calculating the Allowable Income Once the adjusted business income has been determined, the following calculation should be done to determine the total income available to the borrowers for qualifying purposes:
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Calculation: Adjusted business income X (multiplied by) Borrower’s percentage of ownership(minus) Dividend income reported on borrower’s individual return= Total corporate income available to borrower(s)
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February 22, 2011
Section 3.4: Income
3.4-G Self Employment (cont’d) 3.4-G6 Calculating Allowable Income from S Corporations and Partnerships Introduction In order to use income from an S corporation or partnership to qualify self-employed borrowers for a loan, Clients must verify that the borrowers have access to the funds. This information is transferred from the business’ federal tax returns to Schedule E of the borrowers’ IRS Form 1040. Self-Employed Income Analysis Form The Fannie Mae Self-Employed Income Analysis form should be used to determine the borrowers’ allowable share of the adjusted business income. Determining Share of Income The borrowers’ share of business income is transferred to the borrowers’ Schedule E. Refer to the calculation in section above 3.4-G5. Calculating Allowable Income If the borrowers have provided evidence that they have access to a share of the business’ adjusted business income, the following calculation should be done to determine the total income available to the borrowers for qualifying purposes:
Calculation: Depreciation +(plus)Depletion-(minus) Borrower’s proportionate share of business’ total obligations payable in less than one year= Amount to be proportionately added to borrowers’ income
3.4-G7 IRS Forms Quick Reference (FNMA 2009 Selling Guide) The following table lists the IRS forms referenced in this section and provides the full titles. IRS Form Number
Title
Form 1040 Form 1040
U.S. Individual Income Tax Return
Form 1040 Form 1040 Form 1040
Schedule B Interest and Ordinary Dividends Schedule C Profit or Loss from Business (Sole Proprietorship) Schedule D Capital Gains and Losses Schedule E Supplemental Income and Loss
Form 1040
Schedule F Profit or Loss From Farming U.S. Partnership Return of Income
Form 1065
Form 1099-A
Schedule K-1 Partner’s Share of Income, Deductions, Credits, etc. Acquisition or Abandonment of Secured Property
Form 1099-C Form 1099-DIV Form 1099-MISC
Cancellation of Debt Dividends and Distributions Miscellaneous Income
Form 1120
U.S. Corporation Income Tax Return
Form 1065
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