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© 2018 RHS HB-1-3555 SFH Guaranteed Loan Program Technical Handbook

The anticipated amount of income, and likelihood of its continuance, must be established to determine the applicant’s capacity to repay the loan.  The determination of stable and dependable income remains the lender’s responsibility.  GUS does not evaluate the stability and dependability of repayment income in the overall risk evaluation.  The lender must determine the history and stability of earnings prior to entering repayment income into GUS.  Repayment income often differs from the annual income and adjusted income calculations that determine program eligibility.

Income from any source that cannot be verified, is not stable, or will not continue, must not be used in calculating the applicant’s repayment income.  Stable monthly income is the applicant’s verified gross monthly income from all acceptable and verifiable sources that can reasonably be expected to continue for at least the next three years.  For each income source used to qualify the applicant(s), the lender must determine both the source and the amount of the income are stable.  The determination of stable and dependable income remains the lender’s responsibility.

There is no minimum length of time an applicant must have held a position to consider employment income as dependable.  Many low and moderate-income applicants change jobs frequently due to the nature of the employment available.  Applicants in this situation should not be penalized for frequent changes in jobs within the same line of work if, despite the changes, income continuity has been maintained and the income amount has remained at a consistent level.  However, the lender must verify the applicant’s employment for the most recent two full years and verify that the applicant’s income has been stable.  If an applicant indicates he or she was in school or in the military during any of this time, the applicant must provide evidence supporting this such as college transcripts or discharge papers.  If the applicant has recently re-entered the workforce after an absence to care for a family member or minor child, extended medical illness, or other circumstance reasonable to the lender, the applicant must provide evidence.  The applicant should not have any gaps in employment of more than a month within the two year period prior to making the loan application.  It remains the lender’s responsibility to analyze the gaps in employment as it relates to the probability of continued income.  The lender may make allowances for seasonal employment, as is typical in the building or agriculture trades.  In most instances, a two-year history of receiving income is required in order for the income to be considered stable and used for qualifying.  The lender should focus on the applicant’s occupation, tenure, past employment history and probability of consistent receipt.  

Applicants that have not been employed for 12 months with their current employer or have experienced a significant earnings increase are considered high risk. Lenders must ensure the applicant will have the required stable and dependable income to carry the mortgage debt.  Caution must be utilized when the applicant’s employment includes a probationary period.  The lender may consider reasonable allowances for applicants with less than 12 months job time with their current employer under the following circumstances:  (1) the applicant has recently changed jobs but remains in the same line of work, (2) the applicant frequently changes jobs but demonstrates income continuity,  (3) the applicant is a recent graduate, as evidenced by college transcripts, or a recent member of the military, as evidenced by discharge papers, entering the civilian workforce, (4) the applicant has recently re-entered the workforce after an absence to care for a family member or minor child, extended medical illness, or other circumstance reasonable to the lender as further outlined in this Paragraph; and (5) an applicant will begin a new job with a firm offer letter from the employer indicating a start date within 60 days of loan closing (lenders must verify the applicant will have sufficient income, or cash reserves, to support mortgage payments and other obligations during the time between loan closing and the start of employment), this type of allowance is commonly represented by an applicant entering a teaching position with a contract from the school district.  

Many income sources such as commission, bonus, overtime, tips and income from a second job require two years of receipt of income and two years of income documentation.  Notwithstanding the requirements below, in some extraordinary instances less than two years of income receipt for income sources such as commission, bonus, overtime, tips and income from a second job may be acceptable with a documented thorough analysis of the applicant’s income and a determination that the income is stable and likely to continue for the next three years.  If less than two years documentation is utilized for qualifying the applicant, the lender must document in their underwriting analysis the basis for determining the income utilized when qualifying the loan as stable and dependable.  

Other non-employed or not self-employment income sources such as child support, alimony, public assistance payments, social security (including social security received by adults on behalf of minors or by minors intended for their own support – as long as the minor is a member of the household), retirement, etc. can be considered stable to the extent that they are likely to be consistently made by the payer and can reasonably be expected to continue for at least the next three years.  Many factors should contribute the determination and likelihood of consistent payments from other income sources such as:

• Are payment received pursuant to a written agreement, court decree or law?
• How long have payments been received?
• Are payments regular?
• What procedures are available to compel payment of other income?
• Have full or partial payments been made?
• What are the ages of each child for which child support payments are made (if applicable)?
• What is the eligibility criteria governing continued receipt of income, such as age of dependents or accumulation of assets?

Generally, income from self-employment is considered stable and dependable if the applicant has been self-employed for two or more years, supported by documented income tax returns.  Projected or hypothetical income from any source is typically not acceptable for repayment purposes.  

The lender’s permanent case file must retain supporting documentation confirming the stable and dependable income utilized to qualify the loan.  The following will assist lenders to evaluate the stability and continuance of income... This list does not encompass all eligible income types the lender may consider.

A. Salaries, Wages and Other Forms of Repayment Income

The income of each party to the note must be analyzed to determine whether it can reasonably be expected to continue. If the applicant intends to retire within the next 12 months, the repayment income will be the amount of retirement benefits, social security payments, and other retirement income.  

Employed income:  Stable income may be income from primary, secondary employment, including base earnings plus consistent and documented secondary income such as bonuses, commissions, overtime, additional part-time employment or seasonal employment.  All income sources must be documented to determine that the applicant’s income is stable and likely to continue at the level used to qualify the applicant for the mortgage loan request.

Newly employed:  An applicant who has less than a two-year employment and income history can be considered when the lender obtains supportive documentation the applicant was either attending school or training program immediately prior to their current employment history.  For those applicants about to start a new job, if the applicant has a firm offer letter from the new employer indicating the job that will begin within 60 days of loan closing, see Paragraph 9.10 A.15 of this Chapter regarding additional documentation for qualifying an applicant with this type of income.

Re-entering the Workforce:  Applicants who re-enter the workforce after an absence to care for a family member or minor child, extended medical illness, or other circumstances reasonable to the lender and have less than a two-year employment and income history, this type of income source may be considered as repayment income if the applicant has been at the current employer for a minimum of six months and there is evidence of a previous employment history.  

Significant increases or decreases in income level:  When an applicant has experienced a significant decrease in income, the previous higher income level cannot be averaged for repayment purposes unless there is documentation of a one-time occurrence (e.g. injury) that prevented the applicant from working or earning full income for a period of time and proof that the applicant is back to the income amount that they previously earned.  Focus on the most recent earnings and income that it is likely to be received at the level used for qualifying.

When an applicant has experienced a significant increase in income and the lender proposes to qualify the applicant at the higher amount, sufficient documentation to confirm the increased income is stable and likely to continue at the level used for qualifying must be part of the lender’s written analysis of income.

Calculation of Monthly Repayment Income From Primary Employment:  The following table will assist lenders in calculating base earnings from primary employment paid on an hourly, weekly, every two weeks, semi-monthly or monthly basis to qualify the applicant.  The guide will not be applicable in all situations.  The lender remains responsible for determining the amount of income used to qualify the applicant is stable.  A written analysis of the income used to qualify the applicant must be retained in the mortgage loan file.  Documentation must support the lender’s income calculation.  

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Calculation of Monthly Repayment Income – Base Earnings

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Frequency

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Calculation of Repayment Income

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Hourly

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Multiply the hourly pay rate by the average number of hours worked per week; multiply by 52 weeks; divide by 12 months.

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Weekly

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Multiply the weekly income by 52 weeks; divide by 12 months.

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Every two weeks

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Multiply the two weeks income by 26 pay periods; divide by 12 months.

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Twice per month

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Multiply the semi-monthly income by 24 pay periods; divide by 12 months.

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Monthly

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Use the monthly income from the paystub.  Multiply by 12 months.

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Applicants who are paid less than 12 months per year

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Annual salaries may be received over a time period of less than 12 months.  Determine how often; how long the applicant is paid.  Utilize the monthly income based upon calculations above.  Example - divide an annual salary paid 10 months of the year by 12 to arrive at the average monthly income.

Additional Income:  Procedures for treating other acceptable income sources in addition to primary employment are described below.  The lender must determine that the amount of additional income used to qualify the applicant is likely to continue at the level used for loan qualifying.  The monthly income documented in the mortgage file must support the lender’s income calculation.  A written analysis of the additional income used to qualify the applicant must be retained in the lender’s mortgage file.  

1. Overtime and Bonus Income

Both overtime and bonus income may be used to qualify the applicant if the income source has a two year consecutive history of paying overtime and bonuses and the income will likely continue for the next three years.  Income earned for less than one year with the current employer should not be considered for repayment income without significant compensating factors (e.g. the applicant has recently changed from a salary to commission position with the same employer, or remains in the same line of work with a verified history of receipt of these income types).    

When the lender verifies this type of income, the employer must indicate that the overtime and bonus income is likely to continue.  If either type of income shows a continual decline, the lender must provide a sound rationale for the amount included.  If bonus income varies significantly from year to year, a period of more than two years may be used in calculating the average income.  

Calculation of Overtime and Bonus Income:  If the amount of the bonus and/or overtime is consistent in the most recent two years, the amount utilized for repayment income will be the total of the most recent two years divided by 24 months.  Business expenses will be deducted prior to the calculation.  If the applicant has experienced a decrease in overtime or bonus income the lender must determine the amount of income, if any, which can be justified as stable and document their explanation for the decrease.  The calculation of repayment income - when less than a 24 month average is utilized - will be based upon the time frame the lender can support with documentation the income is stable and likely to continue at the level used for qualifying (e.g. the previous 12 months represents the level and stability of income to be received in the future – the lender would divide income received for this period by 12).  

2. Commission Income

The applicant must have a two year consecutive history of receiving commission income and the commission income must likely to continue for the next three years in order to consider the income as stable and dependable for repayment purposes.  Commission income should be averaged over the previous two years utilizing the current employer.  

The applicant should provide the last two years tax returns or W-2 forms along with a recent year to date paystub.  Non-reimbursed business expenses, if any, should be subtracted from gross income when supported by IRS Form 2106.  An individual who claims commission income for less than two years, or shows a decrease from one year to the next, requires significant compensating factors if the commission income is to be included as repayment income. Typically, this example would be an extraordinary instance.

Commissions earned less than one year should not be considered repayment income absent significant compensating factors.  Exceptions may be made in those situations on a case by case basis where the applicant’s compensation was changed from a salary to commission within a similar position with the same employer.  An applicant may also qualify when that portion of earnings not attributable to commissions would still be sufficient to qualify the applicant for the mortgage. 

Calculation of Commission Income:   If the lender determines the amount of commission income is consistent, divide the total of the most recent two-years (minus business expenses when applicable) by 24 months.  A written analysis of the income used to qualify the applicant must be retained in the mortgage file. 

3. Part-Time, Second Job, Seasonal Income and Unemployment

Income from a second job or part-time job may be counted for repayment income if the applicant has worked this position uninterrupted for the past two years and will continue to do so.  This type of income must be likely to continue for the next three years in order to consider the income for repayment.  Second or part-time job income refers to jobs taken in addition to the normal, regular employment to supplement the applicant’s income.  If an applicant’s regular employment is less than a typical 40-hour work week, the stability of that income should be evaluated as any other regular, ongoing primary employment.  This would include as an example, a registered nurse that has been working 24 hours per week for the last year.  

Seasonal employment (e.g., umpiring baseball games in summer or working at a department store during the Christmas shopping season) is considered uninterrupted and may be counted if the applicant has worked the same type of job for the past two years.  Income from a part-time position that has been received for less than two years may be counted if the lender is able to determine through employer verification that the income’s continuance is likely at the level of receipt verified in the past.  Income from part-time positions not meeting these requirements may be considered as a compensating factor, as described in Chapter 11 of this Handbook.

Unemployment compensation associated with seasonal employment may be considered repayment income if the applicant has a two-year history of receipt and the unemployment compensation is likely to continue for the next three years.

To utilize income from secondary employment (second or additional job), seasonal income or unemployment to qualify the applicant, the income must be reported on the applicant’s individual federal income tax return for the most recent two year period.

4. Tax Exempt Income

The standard debt-to-income ratios are based on an assumption the income is taxable.  If a particular source of income is not subject to Federal taxes, for example, certain types of disability payments or military allowances, the amount of continued tax savings attributable to the nontaxable income source may be added to the applicant’s repayment income.  Income that has been verified to be tax exempt may be “grossed up” by 25 percent, in other words, multiplied by 125 percent to “gross up” such income.  No other adjustments for tax exempt income are authorized.  Tax exempt income sources should not be grossed up when calculating annual income.

5. Military Income

In addition to base pay, military personnel may be entitled to additional forms of pay.  Income from variable housing allowances, clothing allowances, flight or hazard pay, rations, and proficiency pay is acceptable provided it is verified as continuous and regular and likely to continue.  An additional consideration may be the tax-exempt nature of some of these payments.

If the applicant is a member of a reserve component of the United States Armed Forces, the lender may consider the reserve duty income for qualifying.  

6. Retirement and Social Security Income

Retirement and Social Security income requires verification from the source (former employer or Social Security Administration), such as a copy of the current award letter or Federal tax returns.  If any benefits expire within the first three years of the proposed loan, the income source may only be considered as a compensating factor in lieu of repayment income.  The Social Security Administration benefit verification letter or equivalent document would specifically state that benefits will expire; otherwise lenders should treat Social Security benefits as likely to continue. 

7. Alimony, Child Support or Maintenance Income

Income in this category may be counted if such payments are likely to be consistently received for the first three years of the mortgage.  The applicant must provide a copy of the divorce decree, legal separation agreement, or voluntary payment agreement, and evidence that payments have been received during the last twelve months.  Payment periods of less than twelve months may be acceptable if the lender can document the payer’s ability and willingness to make timely payments.  Acceptable evidence of payments received includes the most recent 12 months of cancelled checks, or deposit slips, or Federal tax returns, and court records.

When lenders are considering if this type of income is stable, consider the extent that payment is likely to be consistently made by the payor and can reasonably be expected to continue for at least the next three years based on documentation.

8. Interest and Dividends

Interest and dividend income may be counted for repayment income provided that documentation (tax returns or account statements) supports a two-year history of receipt. 

This income must be averaged over the two years.  Any funds derived from these sources, and required for closing, must be subtracted before the projected interest or dividend income is calculated.  Documentation of sufficient assets remaining after closing to support continuance of the dividends and interest income at the level used for qualification for the next three years is required.

9. Employer Differential Payments/Housing Allowances

If the employer subsidizes the mortgage payments through direct payments, this is a housing allowance.  The amount of the payments should be considered gross income to calculate repayment ratios.  It may not be used to directly offset the mortgage payment even if the employer pays the servicing lender directly.  The lender must obtain documentation to demonstrate that the payments are pursuant to an established, ongoing and documented employer program to utilize this type of income for qualifying.  The employer must not be an interested party to the transaction and the payment must continue for the next three years. 

10. VA Benefits

Direct compensation from the U.S. Department of Veterans Affairs (VA), (e.g., regular payments for a service-related disability), can be counted if the VA verifies it.  A VA education benefit, used to offset education expenses, is not an acceptable source of income.  Any amount provided for living expenses may be counted as repayment income.  Any student financial aid received for tuition, fees, books, equipment, materials, and transportation will not be considered in the repayment income calculation. 

11. Government Assistance Programs

Income received under a welfare program, unemployment income, worker’s compensation, or similar government assistance programs can be used for repayment income as expanded upon in this Chapter. It must be documented by the paying agency; the income has been received for the most recent two years and can be expected to continue for three years.  If this income is not expected to last three years, it may be considered as a compensating factor.  Unemployment income requires a two-year documentation of its receipt and reasonable assurance of its continuance.  This may be appropriate for individuals employed on a seasonal basis, such as farm workers or resort area employees.  Applicants with a sole source of unemployment benefits as their earnings are ineligible for a guaranteed loan.

Documentation from the applicable agency that indicates the amount, frequency and the length of time the benefit payments will be received is required.  

12. Rental Income

Rental income received for a property owned and retained by the applicant may be acceptable in limited circumstances, subject to proper documentation as noted in Chapter 8 of this Handbook.  A separate schedule of real estate is not required provided that all properties are shown on the Uniform Residential Loan Application (URLA).  The following is required to verify rental income:

• Long-term current leases.  Net rental income, received for 24 months or more, may be considered stable and dependable income for repayment purposes.  Evidence of long term leases will be documented with the most recent two years of tax returns (including Schedule E of IRS Form 1040) and a copy of the written lease agreement executed by the homeowner and lessee.  Net rental income is considered the two-year average of total rental real estate income reported on IRS Form 1040 Scheduled E.  A two-year average of depreciation and depletion may be added back to the net income or loss shown on Schedule E less any monetary obligation associated with the property not captured on Schedule E (i.e. monthly principal payment).  Positive net rental income is considered as gross income for repayment purposes.  Negative net rental income must be treated as a recurring liability and not as a deduction from repayment income.  The lender must make certain the applicant still owns the property listed by comparing the Schedule E with the real estate owned section of the residential loan application.  

Data entry in GUS for long-term current leases.  Requests submitted utilizing GUS that include the retention of a rental property require specific fields to be completed to assure accurate data is submitted.  Complete the following steps in GUS:

• Complete the “Real Estate Owned" (REO) page in GUS to ensure rents are used to offset the existing mortgage obligation when applicable.  
• GUS auto-calculates net rental income by employing at 25% vacancy factor.  GUS uses 75% of the lender entered amount for gross rental income and subtracts the lender entered amounts for mortgage payments, insurance, maintenance and taxes.
• Lenders may override the auto-calculation on this page when the most recent two years of tax returns evidence a more precise amount of income receipt.  
• On the “Assets and Liabilities” page of GUS, lenders should omit the mortgage obligation for the rental property shown on this page to avoid double counting the debt since it is also reported on the REO page.

Non-GUS manually submitted files for long-term current leases.  Lenders will utilize the two-year average as reported on the Schedule E to determine repayment income.  Depreciation and depletion can be added back into the net rental income.  Mortgage payments (if applicable), insurance maintenance and tax obligations will be subtracted from the calculation.  

• Newly signed leases.  A newly signed lease has no historical basis to conclude that the income is likely to continue.  Rental income that has been received for less than 24 months will not be considered stable and dependable income for repayment purposes.  Applicants who wish to purchase a new principal residence and retain or rent a residence must qualify with all mortgage liability payments.  Income from newly signed leases cannot be used in repayment debt ratio calculations.  The exclusion of rental income will ensure the applicant has sufficient monthly income to meet all mortgage and liability payments.   

Data entry in GUS for newly signed leases.   The “REO” page in GUS must be completed properly to ensure rents are not used to offset any existing mortgage liability.  The following steps to assure accurate data in GUS are required:

• On the REO page, lenders must leave the “Gross Rental Income” field blank when completing the “Mortgage Payments” (if applicable) and “Insurance, Maintenance, and Taxes” data fields.
• The mortgage obligation (if applicable) associated with the retained dwelling must be omitted on the “Assets and Liabilities” page in GUS.  Omission of the mortgage obligation on the “Assets and Liabilities” page is necessary to avoid duplication/double counting of the debt since it is also reported on the “REO” page.

Non-GUS manually submitted files for newly signed leases.  The existing mortgage obligation (including insurance, maintenance and taxes) associated with the retained dwelling must be counted as a long-term liability in the repayment ratio calculation.  Rents received cannot be used to offset the mortgage obligation. 

13. Automobile Allowance and Expense Account Payments

The applicant must have a two-year consecutive history of receiving an automobile allowance and the automobile allowance must be likely to continue for the next three years in order to consider the income for repayment purposes.  

The amount by which an applicant’s automobile allowance or expense account payments exceed actual expenditures may be considered as income.  The applicant must provide IRS Form 2106, “Employee Business Expenses,” for the previous two years to establish the amount of income that may be added to gross income, along with verification from the employer that these payments will continue.  

The monthly debt amount must be treated as a recurring debt.  If the applicant uses the standard per-mile rate in calculating automobile expenses, as opposed to the “actual cost” method, the portion the IRS considers depreciation may be added back to repayment income.  Additionally, the applicant’s monthly car payment must be treated as a recurring debt and must not be offset by the car allowance. 

14. Trust Income

Income from trusts may be counted for repayment income if guaranteed, if constant payment will continue for at least the first three years of the mortgage term, and if it is adequately documented.  Documentation requirements include a copy of the Trust Agreement or other trustee’s statement confirming amount, frequency of distribution, and duration of payments. 

15. Projected Income

Projected or hypothetical income is not acceptable for repayment purposes.  However, exceptions are permitted for income from cost-of-living adjustments, performance raises, bonuses, etc. which is both verified by the employer in writing and scheduled to begin within 60 days of loan closing. For those applicants about to start a new job, if the applicant has a firm offer letter from the new employer indicating the job that will begin within 60 days of loan closing, the income is acceptable for qualifying, and repayment, purposes.  The lender must also verify that the applicant will have sufficient income or cash reserves to support the mortgage payments and any other obligations during the interim between loan closing and the start of employment.  This may be appropriate for situations such as a teacher whose contract begins with the new school year, or a physician beginning residency after the loan is scheduled to close.  However, if the loan will close more than 60 days before the employment begins, the income cannot be counted for repayment purposes.  Lenders should utilize full documentation on this type of income.  In the absence of a payroll statement to support income earned for new jobs, a copy of the contract with the employer that validates the amount of income to be earned should be obtained. 

16.   Mortgage Credit Certificates

If a government entity subsidizes the mortgage payments, either through direct payments or through tax rebates, these payments can be considered as acceptable income if verified in writing.  The subsidy must be used directly to offset the mortgage payment before calculating the qualifying ratios.  See Paragraph 9.11 A of this Chapter for additional information on this subject. 

17. Tip Income

The applicant must have a two year consecutive history of receiving income from tips in order to consider the income for qualifying.  For tip income that fluctuates, the lender must evaluate the income trend and use the amount that is likely to continue for the next three years. 

18. Section 8 Homeownership Assistance Payments

Section 8 homeownership payments paid directly to the applicant or directly towards offsetting the mortgage payment may be considered qualifying income if the payments are likely to continue for the next three years.  If the subsidy is paid directly to the applicant it may be “grossed up” by 25% to compensate for its non taxable status. 

If the subsidy does not pass through the hands of the applicant it should be treated as an “offset” to the monthly PITI (i.e. reduce the monthly PITI payment by the amount of homeownership assistance provided prior to dividing by monthly repayment income to determine the debt-to-income ratio).

GUS may be utilized by lenders when the payment is paid directly to the applicant.  If the payment is not paid directly to the applicant, the lender will be required to manually underwrite the mortgage file.  

See Paragraph 9.11 C of this Chapter for additional information on this subject. 

19. Unreimbursed Employee Expenses

Unreimbursed employee expenses are reported on IRS Form 2106, “Employee Business Expenses.”  The sum of columns A and B on Line 8 represents the total amount spent out of pocket.  The amount of unreimbursed employee expenses must be deducted from repayment income.

B.    Employment by Family-Owned Businesses

Applicants employed, by businesses, owned by family members are required to provide additional income documentation.  Such applicants must provide the normal verification of employment and pay stubs, as well as evidence that he or she is not an owner of the business.  This may include copies of the applicant’s signed personal tax returns, current paystub or payroll ledger signed by the business accountant or payroll administrator, or a signed copy of the corporate tax return showing ownership percentages.

C.    Self-Employed Applicants

An applicant with a 25 percent or greater ownership interest in a business is considered self-employed for the purpose of calculating repayment income.  The business may be a sole proprietorship, a partnership (limited or general) or a corporation.  

A self-employed applicant introduces an additional layer of risk to a mortgage loan request due to the uncertain nature of future income.  GUS will not take this additional risk into consideration in the overall risk evaluation.  The lender remains responsible to determine the income source utilized, in qualifying, is a stable, consistent source that will continue to be received at the level utilized for repayment income purposes. 

1. Minimum Length of Self-Employment

Income from self-employment is considered stable and dependable if the applicant has been self-employed for two or more years.  Because of the high incidence of failure during the first few years of a new business, income from individuals self-employed for between one and two years can only be counted if the individual has at least two years previous successful employment (or a combination of one year of employment and formal education or training) in a related occupation or profession at the same or greater level in the same or similar occupation.  If the applicant cannot demonstrate selfemployment earnings for the previous two years, the lender’s underwriter must review the applicant’s reasonable probability of earnings based on a market feasibility study or business plan and pro forma financial statements for the business.  The lender must also consider the applicant’s experience in the business prior to considering the income for qualifying purposes.  If the underwriter is unable to support the income with the documentation required, the income should not be utilized for repayment income purposes.  The income from applicants self-employed for less than one year cannot be counted as repayment income.

When additional income the applicant draws from the applicant’s corporation, partnership or S-corporation is utilized for repayment income, additional documentation is required to verify the applicant has a legal right to the additional income.  Lenders can obtain a corporate resolution or other comparable document that establishes that right.  Also confirm the applicant’s percentage of ownership of the business entity from a review of business tax returns, letter from the accountant for the business or similar documents.  The analysis must support that the business is clearly capable of providing the applicant with the additional income used to qualify.

A written analysis of income utilized to qualify the applicant must be retained in the lender’s mortgage file.  As part of the analysis, any increase or decrease in business income must be documented and justified to support a determination that the income used to qualify the applicant is stable and likely to continue for the next three years.  It may be necessary to obtain additional years’ tax returns when the applicant’s self-employment income fluctuates to determine the stability of income. If the applicant’s income is not utilized to qualify the applicant for repayment, the individual federal tax return is required to determine if there is a business loss that may have an impact on the stable monthly income utilized for qualifying.  If a business loss is reported, additional documentation may be necessary to evaluate the impact of a business loss on the income used for qualifying the applicant for repayment.    For the purposes of computing annual income to qualify the household, business losses will be treated as zero in the calculation.  Business losses when calculating repayment income will be deducted from repayment income prior to calculating debt ratios. 

2. Documentation

The following documentation for self-employed individuals is required to establish capacity to repay the loan:

• Signed and dated individual tax returns, plus all applicable schedules, for the most recent two years.  If the applicant has been self-employed for less than two years, the individual federal tax returns must reflect at least one full year of selfemployment income.  Lender’s must use extreme discretion with applicant’s who have been self-employed for less than two years;
• A year to date profit-and-loss (P&L) statement and balance sheet (not required to be audited);
• Signed copies of the Federal business income tax returns for the last two years, with all applicable schedules, if the business is a corporation, an “S” corporation, a partnership, or a limited liability corporation. 

3. Analyzing Self-Employment Income  

The lender must establish the applicant’s earnings trend over the previous two years, but may average the income for repayment purposes over three years if all three years’ tax returns are provided.  If the applicant provides quarterly tax returns, the analysis can include income through the period covered by the tax filings.  If the applicant is not subject to quarterly tax filings or does not file quarterly returns Form IRS 1040 ES, “Estimated Tax Payment Voucher,” the income shown on the P&L may be included in the analysis provided the income stream based on the P&L is consistent with the previous years’ earnings.  If the P&L statements submitted for the current year show an income stream considerably greater than what is supported by the previous years’ tax returns, the analysis of income must be predicated solely on the income verified through the tax returns.

Lenders must carefully analyze the individual business’s financial strength, the source of its income, and the general economic outlook for similar businesses in that area to determine if the business can be expected to continue to generate sufficient income for the applicant’s needs.  Annual earnings that are stable or increasing are acceptable.  Conversely, income for an applicant whose business shows a significant decline in income over the period analyzed may not be considered adequate, dependable, and stable.

There are five basic types of business structures (sole proprietorship, corporations, “S” corporations, partnerships, and limited liability corporations), each of which will require slightly different forms of analysis.  Attachment 9-E contains detailed information about analyzing tax returns for self-employed applicants. 

4. Calculation of Self-Employed Income

The lender’s calculation of a self-employed applicant’s average monthly income must be based on a review of the applicant’s complete individual federal tax returns (Form 1040) including W-2’s and K-1’s (if applicable).  Additionally the applicant’s complete business tax returns (Forms 1120, 1120S and 1065), when applicable must be analyzed.   A written analysis of the applicant’s self-employed income on Fannie Mae Form 1084, “Cash Flow Analysis,” and Fannie Mae Form 1088, “Comparative Income Analysis,” (or a comparable form) is encouraged to document a trend analysis of the applicant’s business.  Non-cash items such as depreciation and depletion may be added back to adjusted gross income for the purpose of determining qualifying income.  

The following allowable IRS deductions may be added to net profit (item #31 on Schedule C, or item #36 on Schedule F):

• Depletion (item #12 on Schedule C)
• Depreciation (item #13 on Schedule C or item #16 on Schedule F)

Net Profit + Depletion + Depreciation = Repayment Income 

5. How to Treat Business Debts  

Traditionally, the primary business structure that many of our self-employed applicants engage in is a sole proprietorship.  The success of this type of endeavor depends largely on the individual owner, and business income or loss is reported in the individual owner’s personal tax return.

Also, although the individual owner has personal liability for all debts of the business in a sole proprietorship, business related debts are often paid with business funds, rather than personal income.

If a debt such as a car loan is paid through the business, the debt does not need to be included in debt ratio calculations as long as documentation is provided that the debt is being paid by the business.  Documentation that the debt payments are made by the business may include 12 months of cancelled business checks.

D. Income from Assets

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Attachment 9-G of this Chapter provides optional verification forms for the lender’s use in verifying non-employed income or adjusted annual income deductions as follows:

Also available is an optional form to record an oral verification of employment.