How Lenders Generally Look At Different Types of Income
Home buyers should have at least 2 years history of employment in the same field or work. This can in some cases include an applicant educational history. If you find you have less than 2 years due to attending college or military duty, consult with your lender on what documentation will be required to consider you income.
All income must be analyzed to determine if it will be likely to continue for the first five years of the mortgage. If you are planning to retire during this time you will most likely be required to qualify at the projected retirement income. Consult with your human resource department to provide a projection letter for their forecasted income after retirement. You will also have to provide evidence of sufficient assets to support this income, i.e. 401K Plans, and portfolio statements supporting your stated income.
The effective income of both the client and co-applicant is considered in determining the ability to meet the proposed mortgage payment and all other monthly obligations. Income derived from employment must be verified by using a VOE or alternative employment documents provided by you, such as 30 days consecutive pay stubs within 90 days of the closing and W-2’s for the proceeding 2 years. The VOE must be sent to the employer or if using alternative documents you must secure original document and make copies, then certify them as “True Copies of the Originals.” When reviewing your employment history you may be asked to provide a letter of explanation for any lengthy gaps between employers.
If you are a member of a union and receives job assignments directly from the union, then a verification of employment should be sent to the union office in order to verify your rate of pay and their standing in the union. Tax returns for 2 years will be required, with W-2’s from each employer for the said time frame. Additionally, verifications of employment will be required from each employer, so help your process out and be detailed with contract information.
Though a union may verify a rate of pay, the rate may not be used unless you have worked steadily with no gaps in employment with the union for the past two years. Should there be gaps, an average in income will be used to qualify. It is important to note that if you work directly for a company and a member of a union, then you most likely be treated like any other salaried employee by requesting information from you company by means of a VOE.
Overtime & Bonus
A 2-year history for this type of income is required, along with verification of employment and two years tax returns. Large variances from year to year requires more than a 2-year history. A steady decline from year to year could preclude use of this type of income. Income received may be considered only if it can be established that the income will continue during the foreseeable future.
To consider overtime income, the employer must verity the number of hours worked in overtime per week and that it is likely to continue. Pay stubs showing year to date earning plus W-2 for the previous 2 years will be required to average this income.
When you receive income from bonuses, this income is not likely to be considered unless it can be established as continuous. Bonus income must be likely to continue and the employer needs to provide the amount of the bonus income for the previous 2 years. This income will then be averaged. It will also be necessary to determine the manner of payment of the bonus, whether they are paid annually, semiannually, quarterly, or monthly. Sometimes a lender may choose to use the bonus income to offset a debt, rather than being considered as effective income.
Part time income can be used to qualify if it has been worked for two years and is expected to continue. Seasonal income can be considered if you have worked the same job for the at least two years and expects to be rehired. When income is from a part time job, the concern of the lender is for the well being of the client. If it does not appear that you will not get sufficient rest due to working excessive hours per week (60-80), the part time income will not be considered. A letter from you may be needed, setting out the work schedule from his primary and part time jobs, indicating the sufficient rest is received in order for all the income to be considered.
Commission income requires to be averaged for the past two years. You most likey will be required to provide the past two years tax returns and a current pay stub. Any unreimbursed employee business expenses must be deducted from your income. This is usually shown on IRS Form 2106 or Schedule C in some cases. Any decrease in commission income requires a significant compensating factor to consider the income. If the commission has been received for less than 2 years, it usually will not be counted as income unless you have been promoted within the same company and this pay structure now includes commissions. A letter for the employers stating your likelihood of continued commission income would be required. When all or a major portion of yours income is derived from commissions, it will be necessary to establish the stability of such income. This stability is dependent upon the length of the client’s employment. Several items need to be determined when taking the application in order to properly pre-qualify the client. These items include:
- If a base salary is stated, whether it is guaranteed or a draw against commissions.
- Determine if the commission income stated includes any other type of income such as a car allowance or bonus.
- When are commissions received i.e., monthly, quarterly, semiannually, etc.
- Whether you receives company paid expenses or does he pay expenses out of pocket.
- Do you have a company car or receive a car allowance.
Alimony/Child Support Received
Alimony and Child Support must continue for at least three to five years. To use this income you must provide a copy of the divorce or child support awards statement along with verification these funds have been paid to you in a timely manner. You can do this by providing 12 months canceled checks or bank statements showing the deposits and a letter from the court of authority may also be required to confirm payments are received and are current.
Interest and Dividends
Interest and Dividend income will be verified through securing bank statements confirming the balance of accounts that have been generating income for the past two years as shown on Schedules B and D of you tax returns for the past two years.
Rental income is verified for several different documents and/or a combination thereof. If the subject property is a two to four unit development you will need to provide copies of lease agreements currently on the property that can be provided by the seller if it is a purchase, and forecasted rent from the Operating Income Statement Form 216 completed by the appraiser. If you have other income property they will need to provide tax returns for the past two years with Schedule E income showing the income average, along with current leases on the properties. Prospective and current income may be taken into account. Appropriate adjustment will be applied to reduce the estimated rental income by analyzing operating expenses and vacancy losses for the market.
FNMA requires that all investment properties sold to them must meet specific requirements stated on the Operating Income Statement FNMA Form 216 that is completed by the appraiser. In order for an investment property to be an acceptable risk, it must support itself financially. This means that the debt service coverage ratio as calculated by the appraiser must be at least 90%. On an owner occupied 2-4 family residence, FNMA allows a debt service coverage of 75%.
To determine the income-producing ability of an investment property, the appraiser completes the following forms.
- Single Family Comparable Rent Schedule Form 1007 for single-family properties.
- Small Residential Income Property Form 1025 for 2-4 family properties; and
If the property is currently rented, leases must support the forecasted rents. This does not mean the forecasted rents must be equal to the rents in the leases. The appraiser will use forecasted rents in lieu of actual rents to determine the debt service coverage ratio.
If the cash flow is positive, the lender will show the income as a positive cash flow for the client. If the cash flow is negative and the debt service ratio is 90% or 75% respectfully the loss must be included in the client’s monthly obligations.
In addition to having at least 3 months PITI in reserves, the client must have adequate reserves of one year’s replacement cost.
FHLMC requires that all investment properties sold to them must have a completed “Rental Income and Expense Analysis” Form 65C completed by the lender.
Anticipated rental income from units not occupied by the client must be substantiated by using the income approach on the appraisal and obtaining copies of the present leases, income and tax statements and other sources deemed reliable. BBCLP will complete Form 65C, in lieu of completing the proposed “Monthly Housing Expenses” section of the URLA. After deducting any income received for furniture, an adjustment factor of 75% is to be employed in calculating the Proposed Rental Income.
- The client must demonstrate experience in successfully managing investment property.
- The client has sufficient remaining liquid assets after closing which may be used to supplement payment during
- Vacancies and to make regular and emergency repairs to the property as necessary.
Any rental income related to a property owned by you in a previous tax year must be substantiated by the prior years tax returns. Rental income not substantiated by tax returns must be verified by other valid means such as a settlement statement and lease agreements.
When you are relying on rental income on the subject property to qualify for the loan, they must maintain rent loss insurance. Rent loss insurance compensates the client for a loss or reduction in rental income caused by fire or any other casualty covered by the hazard insurance policy. This is a standard provision contained in most hazard policies for rental dwellings. Advise your applicant that when securing a policy from an insurer they will be required to have at least 6 months coverage for rental loss in their policy.
Only the amount that exceeds the actual expenses as shown on IRS Form 2106 can be used as income. The client will need to provide two years tax returns in addition to verification from the employer that auto expense payments will continue for the foreseeable future. If there is a loss, it must be treated as a debt, and indicated on the job related expenses on the URLA.
Trust income can be used if it will continue for at least three to five years. You must provide a copy of the trust agreement or any other documents that will confirm the amount, frequency, and duration of the payment.
Raises, bonuses, cost of living allowances, etc., can be used in some cases if scheduled to begin within 60 days of closing. There must be a non-revocable contract in place to consider this income.
Employment by a Family Owned Business
For you that are employed by a family member, you may be asked to provide pay stubs, W-2’s and evidence you have no ownership interest in the business.
If you have 25% or more ownership in the business, you are considered self employed. Tax Returns for two years plus an unaudited balance sheet signed by you must be provided. Stipulation if you have less than 2 years self-employment history your income might still be consider if you have a history of employment in the same field or recent formal training. In any case, you will need to be prepared to provided at least one complete tax cycle and a profit and loss statement.
When you are a self-employed applicant you will most likely need to provide the following documents to have you income analyzed.
- Two years personal Tax Returns with all schedules
- Two years Business/Corporate Tax Returns as supported on the Schedule E for a Sub S corporation. Keep in mind there are two types of corporations and only the sub corporation will be shown on your personal tax returns.
- A year to date profit and loss statement.
- A balance sheet.
- In some cases the lender may require a business credit report.
Recently Discharged Veterans
If your prior employment was military duty, a copy of their DD Form 216 should be provided. This is their separation or discharge form from military service, and shows what specialties training the veteran had while servicing.
All gaps since the discharge must be explained. It is acceptable to use income from current short-term employment if it can be established that while in the military you work was similar to your current line of work.
If you are in a new line of work, than his job in the military, a statement from you would be required regarding the training previously received to perform your new job. If your employer indicated that you are a “trainee” or “on probation”, the loan will most likely not be approved until you have completed your training period.
A veteran retiring after twenty years of service or more, whose retirement pay is not sufficient to meet the mortgage payment and other debts, needs only minimal income from other employment. It would be proper to give consideration to income from his new job is he had some training for it previously. However if they were in a probation period the above statement would apply.
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