Slide 1

Basics of Underwriting Series:

Analyzing Income

June 2009

©2009 Fannie Mae. All Rights Reserved

Welcome to the Basics of Underwriting series. This series is an introduction to Fannie

Mae’s manual underwriting guidelines. For information on using Fannie Mae’s
automated underwriting technologies, Desktop Underwriter and Desktop Originator,
please visit eFannieMae.com under the Training and Education tab.

This module is an overview of the various types of income a borrower may rely upon in
qualifying for a mortgage loan which are permitted per Fannie Mae’s Selling Guide.

My name is Phil Corriveau and I’ll be your presenter today.

Slide 2

Tips for viewing this seminar

©2009 Fannie Mae. All Rights Reserved 2

Before we get started, here are a few tips to help you get the most out of this
presentation:
To hear the voiceover narration for each slide, make sure that the volume is turned up. If
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To navigate between slides, click the Forward or Back arrows.
Or click a slide title on the Outline tab to go directly to any slide in the presentation.

You are encouraged to download and print out a copy of this course by selecting the
Attachments menu at the top of this screen.
Slide 3

Course Objectives

At the end of this presentation you will:

 Understand the types of income used to qualify

borrowers
 Know how to document income

©2009 Fannie Mae. All Rights Reserved 3

In this module I will discuss the various types of income that are used to qualify a
borrower, what type of documentation you will need for this income and where to find
help in the Fannie Mae Selling Guide.

A borrower must have a history of receiving stable income from employment or other
sources and a reasonable expectation that the income will continue to be received in the
foreseeable future (usually for three years). We have no minimum history requirement
for a borrower's receipt of income—as long as the lender can determine that the
borrower's income is stable, predictable, and likely to continue. In general, unless there
is evidence that the income will no longer be received, the lender should assume that it
will continue.

There are other sources of income, such as certain types of disability benefits (for
example, Social Security Disability Insurance benefits or Veterans Disability
Compensation benefits, among others) that do not have defined expiration dates. For
such cases, the documentation should indicate the income type. When the lender
believes or knows that the income falls in a category that does not have a defined
expiration date, the lender may conclude that the income is considered stable,
predictable, and likely to continue and is not expected to request additional
documentation from the borrower. Please see the Selling Guide for additional
information concerning disability benefits.

Typically, when a borrower has been generating income for two or more years from
either part-time or full-time work with any number of employers, the lender does not
need to look at an extended income history for the borrower. Rather, the lender may
base its underwriting decision on the borrower's current income. However, information
that will help the lender better understand the nature of the borrower's income, its
stability, and likelihood of continuing is not always available from the current paystub
alone. That is why we require the lender to obtain two years of documentation for a
borrower's employment and income history.

Please keep in mind that Desktop Underwriter and Desktop Originator offer more
streamlined documentation requirements than those reviewed in this module. For more
information on income documentation in DU, please refer to the Selling Guide and
eFannieMae.com.
Slide 4

Establish How the Borrower is Paid

 Salary or Hourly
 Overtime, bonus or commission
 Unreimbursed expenses
 Self-employed or Independent Contractor
 Employed by family member

©2009 Fannie Mae. All Rights Reserved 4

The first element in determining how to document a borrower’s income is to establish

how the borrower is compensated…

• Is he or she paid a salary or hourly wage?

• Does he or she earn overtime, bonus or commission income?
• Does he or she have business expenses that are not reimbursed by his or her
employer?
• Is he or she self-employed or an independent contractor?
• Is he or she employed by a family member?

The answers to these questions are going to help you establish what types of
documentation you will need.
Slide 5

Base Salary and Hourly Income

Eligible full-time income

– Two year history
– No job gaps
Required documentation
– One W-2 and a pay stub with YTD income
– Verification of employment
– 2 years of tax returns
– Reduced documentation with DU

©2009 Fannie Mae. All Rights Reserved 5

The borrower must be employed for two years without significant job gaps. There are
two exceptions to this rule:

First, if the borrower has just graduated from school, the time in school may be counted
toward the two year requirement. You will need to obtain documentation of the
borrower’s recent education, such as transcripts for the last two years or a recently
issued diploma or certificate.

The second exception is when the borrower has just re-entered the work force after an
absence to care for a family member, they only need to be employed for one year in
order for the income to be eligible to be included in the transaction.

To document this income, you’ll need:

• The borrower’s most recent W-2 form for the previous year and a current paystub
representing 30 days of year-to-date income that is less than 30 days old at the
time of application; OR
• A written verification of employment completed by the borrower’s employer which
has not passed through the hands of any interested party to the transaction
(including the loan officer); OR
• Copies of the borrower’s most recent two years Federal income tax returns which
the borrower has signed, along with their permission to reverify this information
with the IRS, typically done with IRS Form 4506-T

Remember, if you use DU or DO, you may find that reduced documentation will be
indicated in the Underwriting Findings Report. This will indicate the minimum
documentation that is permitted for your loan according to its unique risk characteristics.
Slide 6

Calculating Income

Hourly wage earner

Hourly rate x # hours worked per week = weekly pay
Weekly pay x 52 weeks / 12 months = Monthly Income

Weekly salary
Weekly rate x 52 weeks / 12 months = Monthly Income

Biweekly salary (every other week)

Biweekly rate x 26 pay periods / 12 months = Monthly Income

©2009 Fannie Mae. All Rights Reserved 6

This slide provides you with a job aid of formulas for calculating monthly income.

It is essential that your income data is correct and up to date. Remember that we are
trying to establish the borrower’s willingness and ability to repay the mortgage loan for
which they have applied.

Look at the dates for the pay periods to be sure that you are calculating income correctly.
For instance, if you have a borrower that earns $ 2,500 per pay period, and is
compensated on a Bi-weekly basis, they earn $ 2,500 times 26 pay periods per year
divided by 12 months equals a monthly salary of $5,416.67. If the borrower is paid semi-
monthly (on the first and fifteenth of the month, for example), and earns the same $ 2,
500 per pay period, his or her monthly income is $ 5,000.

Also, when reviewing a paycheck stub, check to see if the borrower has any deductions
for debts that are payroll-deducted. Some of these, such as child support or a credit
union loan, may not be reflected in the borrower’s credit report but should be counted as
monthly recurring obligations when you calculate the borrower’s debt-to-income ratio.
We will cover this in detail in the Assets and Liabilities Module of this series.
Slide 7

Overtime and Bonus Income

 Two-year average
 Ensure it will continue
 Lesser documentation required with DU
 May not use overtime or bonus income from a new job –
even when the previous job paid this type of income
 No projected income for bonus recipients

©2009 Fannie Mae. All Rights Reserved 7

In order to consider overtime or bonus income as stable and recurring, the borrower
must have a two-year history of having earned it from the same employer. You also
need to be assured that this type of income is likely to continue in the future.

If the borrower has a new job with overtime or bonus income and also earned overtime
or bonus on their previous job, you may not average the income from the former job.
We cannot be assured that the new employer is going to have the same amount of
overtime for the borrower or the same bonus structure - even if it is the same line of work.

Also, you may not count bonus income that the borrower has not yet received.
Slide 8

Commission Income

 Income is > 25%, must review tax returns

 Average two years (no year-to-date)
 Less than two years; at least one full year on returns
 Establish an “earnings trend” - if declining, may not
average
 Unreimbursed expenses (Form 2106)

©2009 Fannie Mae. All Rights Reserved 8

If 25% or more of the borrower’s income is derived from commissions, you will need to
analyze the borrower’s most recent two years Federal income tax returns. Using these
tax returns, average the two years of commission income minus any unreimbursed
business expenses that are shown on IRS Form 2106.

In calculating commission income, you may not use any year-to-date commission
income from pay stubs.

When you average income, you also need to be aware of the earnings trend. Is the
income increasing from year-to-year? If so, average both years. If you note a decline
from the previous year, you may need to investigate the causes before determining how
to calculate the borrower’s income in a way that represents their actual current earnings.
Slide 9

Part Time Income & Second Jobs

 Uninterrupted employment for two years

 If going from part-time to full, must verify
 Less than two years okay if:
– Not less than 12 months
– Borrower returned to workforce
– Took part-time job to supplement lost overtime income

©2009 Fannie Mae. All Rights Reserved 9

All part time or second job income needs a two year history to be counted as stable and
recurring income.

If a borrower who has been working part time indicates that they are going to increase
their hours to full time, you must verify with his or her employer the number of hours they
will be scheduled to work per week and the likelihood of continuance.

In some instances, it may be acceptable to use income to qualify a borrower who has
worked a part time job for less than two years. This may be a borrower who has
recently returned to the work force or who has taken another job to supplement previous
part-time income or overtime income from his or her primary job that has been
discontinued.
Slide 10

Self Employment Income

 25% or greater ownership in business

 Sole Proprietorship, Partnership, S-Corp, or Corporation
 2 years of income tax returns
 No longer need a profit and loss statement
 DU may require reduced documentation

©2009 Fannie Mae. All Rights Reserved 10

The Selling Guide details Fannie Mae’s requirements for documenting income from a
self employed borrower. Typically, you will review the borrower’s most recent two years
filed Federal income tax returns. Income is reported to the IRS according to the manner
in which the business is organized.

A Sole Proprietor is required to report his or her income on IRS Form 1040, Schedule C
or IRS Form 1040-EZ, Schedule C-EZ.

If the business is organized as a Partnership (whether limited or general), the

partnership files IRS Form 1065 Partnership Return. The borrower’s portion of the
partnership income will be distributed to him or her via IRS Form K-1, and he or she will
pay taxes on this portion of the partnership income on the personal tax return IRS Form
1040, Schedule E.

If the business is organized as an S Corporation, the S Corporation files IRS Form 1120-
S and the borrower will receive IRS Form K-1 and will File IRS Form 1040, Schedule E
to report his or her share of the S Corporation income.

A Corporation files IRS Form 1120 and pays corporate taxes on its business income.
The borrower may earn W-2 income from the corporation as well as dividends and
interest. You may calculate his or her wages from an average of the two most recent W-
2 forms. Dividend and interest income from the corporation will be disclosed on
Schedule B of IRS Form 1040.

Remember that in underwriting the risk of a loan application we must review all the data
presented to us. If the borrower’s income appears to be declining from year to year, the
reason for the decline needs to be determined and analyzed. It may be more prudent to
take an average of only the most recent twelve months’ income if this portrays a more
realistic assessment of the borrower’s income.

If you would like to learn more about self employment income, we offer a companion
recorded web seminar “Understanding Form 1084 for Self-Employed Borrowers”—which
looks at Form 1084 line by line. Like this recording, you’ll find it on eFannieMae.com.
Slide 11

Seasonal Income

 Two year history of income

 Reasonable assumption of returning
 Examples:
– Outdoor workers, income tax preparers, holiday
workers (unemployment income is acceptable)

©2009 Fannie Mae. All Rights Reserved 11

Any income that is consistent may be used to qualify a borrower…even if it is earned

only on a seasonal basis.

Consistency is the key. If you can document receipt of this income year after year and
the likelihood exists that the income will continue for the next three years or more, you
may include this income in the borrower’s monthly qualifying income.

Seasonal workers may also receive unemployment compensation during their off-
season months. This income may be verified on page 1 of the borrower’s IRS Form
1040. Be sure to take an average over the most recent 24 months.
Slide 12

Other Income

 Military  Trust Income

 VA income  Capital Gains
 Notes Receivable  Rental
 Royalties

©2009 Fannie Mae. All Rights Reserved 12

Military personnel may be entitled to different types of pay. Flight or hazard pay, rations,
clothing allowance, quarters' allowance, and proficiency pay are acceptable sources of
stable income, as long as the borrower will continue to receive the income. Income paid
to military reservists while they are fulfilling their service obligations is also acceptable if
it satisfies the same stability and continuity tests that we apply to other types of second-
job income.

Most VA benefits are acceptable if they are documented by a letter from the Department
of Veterans Affairs and will continue for at least three years. Education benefits are not
an acceptable source of income because they are used to offset actual education
expenses.

Payments on notes receivable must continue for at least three years. Fannie Mae
requires a copy of the note to establish the amount and length of repayment. A borrower
must provide evidence that he or she has received the repayment funds for at least the
past 12 months. Payments on a newly executed note may not be used as stable income,
but may be used as a compensating factor.

A borrower may use up to 75% (minus PITI) of anticipated rental income for investment
properties that are the subject property. Of course, certain documentation requirements
and other conditions apply. Please refer to the Selling Guide for the appropriate
guidelines on rental income.
Slide 13

Non-taxable Income

 The non-taxable portion of Social Security, Welfare,

Retirement, Disability etc. may be grossed up by 25%
 Must have one year history of receipt and continue for
three years

©2009 Fannie Mae. All Rights Reserved 13

Some income is not taxed by the IRS. In this case, you may “gross up’ this source of
income by 25%. The reason for this is that Fannie Mae’s debt-to-income ratio is
calculated using pre-tax income because most borrowers’ are earning taxable income.
In order to gross up non-taxable income, take the monthly income TIMES 1.25.

The borrower must have at least a one year history of receiving the non-taxable income
and it must be likely to continue for at least three years.
Slide 14

Retirement, Social Security & Disability

 Determine if taxable or non-taxable

 May gross up 25% for non-taxable
(Non taxable income x 1.25 = grossed up income)
 Award Letter, Monthly direct deposit, 1099
 Same requirements for continuance for three years

©2009 Fannie Mae. All Rights Reserved 14

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 two most recent bank statements. The lender
must determine that the income is expected to continue to be received for at least three
years.

For Social Security benefits that have defined expiration dates, they must have a
remaining term of at least three years Acceptable verification of Social Security income
includes a photocopy of the award letter, copies of tax returns, or copies of the
borrower's recent bank statements.

Documenting disability income can sometimes be challenging. This again, is where the
underwriter needs to use common sense to make sure that the documentation obtained
supports the establishment of continued income. It is difficult for anyone (social security,
employer, or medical doctor) to commit in writing that the likelihood of continuance of
this income exists. You may be able to get a statement from an employer that when the
borrower is ready, they will have a job to return to. If a borrower has been receiving
social security disability for several years, the likelihood is that it will continue.
Slide 15

Alimony and Child Support

 12 months of receipt
 6-12 months receipt – considered stable if it doesn’t
represent more than 30% of the total gross income

©2009 Fannie Mae. All Rights Reserved 15

When a borrower has been receiving payments for alimony or child support for at least
12 months, the income is considered stable income.

When a borrower has been receiving payments for alimony or child support for between
6 and 12 months, the income may be considered stable income as long as it does not
represent more than 30% of the total gross income that is used to qualify the borrower
for the mortgage.
Slide 16

Alimony and Child Support (cont’d)

 Less than 6 months - used as compensating factor

 Verify with the applicable pages of the decree
 Must have three years continuance

©2009 Fannie Mae. All Rights Reserved 16

When a borrower has been receiving timely payments for alimony or child support for
fewer than 6 months, the income may not be considered as stable income -- although, if
the income is adequately documented, the lender may use it to justify a higher qualifying
ratio.

When a borrower has been receiving full or partial payments for alimony, child support,
or maintenance on an inconsistent or sporadic basis, the income may not be considered
stable income and may not be used to justify a higher qualifying ratio.

Alimony and child support income must be verified with the appropriate pages of the
divorce decree, settlement agreement or paternity judgment and the borrower must
document timely receipt of the payments.

As with other types of income, alimony and child support income must be likely to
continue for at least three years.
Slide 17

Foster Care Income

 Two-year history of providing foster-care services

 Likely to continue
– If borrower has not received for two full years, may
count if at least a 12-month history of foster care
and income does not represent more than 30% of
the total gross income

©2009 Fannie Mae. All Rights Reserved 17

Foster care income may also be used for qualifying. The borrower must have a two-year
history of providing foster care services, and the foster care must be likely to continue. If
the borrower has not received foster care income for a full two years, you may count it
as recurring income if the borrower has received it for at least 12 months, and it does not
represent more than 30 percent of their total gross income.

With foster care income, averaging is especially important. For example, a borrower
may have approval to care for up to four children, but may have less than four children in
their care at given moment. Please average the borrower’s foster care income over the
last two years to provide stable and recurring income.
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Boarder Income & Food Stamps

 Boarder income is only a compensating factor

except for the Community Lending Mortgage
(Fannie 97 etc.) where 30% may be used in
ratios. Exception: Disabled borrower w/ live-in
aide.
 Food stamps, welfare, Aid to Dependent
Children, may also be used to qualify the
borrower

©2009 Fannie Mae. All Rights Reserved 18

For a community lending mortgage, such as MyCommunity Mortgage, the rental

payments that a borrower receives from a relative or non-relative who resides with the
borrower may be considered as acceptable stable income -- in an amount up to 30% of
the borrower’s total gross income that is used to qualify the borrower for the mortgage.
This is acceptable if the boarder has lived with the borrower for the last 12 months and
signs a statement stating that they intend to continue renting a room from the borrower
for the foreseeable future. For more details, please refer to the Selling Guide.

Income from public assistance may also be considered as acceptable stable income if it
is properly documented, has been received for the past two years, and is expected to
continue to be received for at least three years from the date of the mortgage application.
Remember…this income may contain a non-taxable portion that you may gross up by
25%.
Slide 21

Resources
 Printout of this course
 eFannieMae.com
– Announcements
– Publications
– Web seminar
 Housing Finance Institute™

Please be advised that the material provided in this training presentation is

for informational purposes only, and that it does not modify and is not a
replacement or substitution for the information found in the Selling/Servicing
Guides, specific product guides, and/or the terms of your Master Agreement
or Master Commitment or any other contract you have with Fannie Mae.

©2009 Fannie Mae. All Rights Reserved 21

Thank you for viewing this training. We hope you found it helpful. Shown here are a list
of resources if you want to find out more.

eFannieMae.com offers valuable information for lenders. There, you will find forms,
summaries of Fannie Mae announcements, technology information, and other
publications. On this web site, you can also find out about the Housing Finance Institute,
which is held each year in various cities across the country and covers such topics as
underwriting, servicing and secondary marketing.

Additionally, I remind you that this recording is just one in our Basics of Underwriting
Series. Other recordings cover traditional credit, non-traditional credit, and assets and
liabilities. Like this one, you can access the recordings anytime on eFannieMae.com.