II.A.5.b. Income Requirements (Manual) (09/14/15)

Owned by Kacey Olson
Nov 20, 2018
24 min read

© HUD Single Family Housing Policy Handbook 4000.1

Effective Income Definition

Effective Income refers to income that may be used to qualify a Borrower for a Mortgage. Effective Income must be reasonably likely to continue through at least the first three years of the Mortgage, and meet the specific requirements described below.

Included in this section are:

i. General Income Requirements (Manual)
ii. Employment Related Income (Manual)
iii. Primary Employment (Manual)
iv. Part-Time Employment (Manual)
v. Overtime and Bonus Income (Manual)
vi. Seasonal Employment (Manual)
vii. Employer Housing Subsidy (Manual)
viii. Employed by Family-Owned Business (Manual)
ix. Commission Income (Manual)
x. Self-Employment Income (Manual)
xi. Additional Required Analysis of Stability of Employment Income
xii. Other Sources of Effective Income (Manual)

i. General Income Requirements (Manual)

The Mortgagee must document the Borrower’s income and employment history, verify the accuracy of the amounts of income being reported, and determine if the income can be considered as Effective Income in accordance with the requirements listed below.

The Mortgagee may only consider income if it is legally derived and, when required, properly reported as income on the Borrower’s tax returns.

Negative income must be subtracted from the Borrower’s gross monthly income and not treated as a recurring monthly liability unless otherwise noted.

ii. Employment Related Income (Manual)

(A) DefinitionEmployment Income refers to income received as an employee of a business that is reported on IRS Form W-2.

(B) StandardThe Mortgagee may use Employment related Income as Effective Income in accordance with the standards provided for each type of Employment related Income.

(C) Required DocumentationFor all Employment related Income, the Mortgagee must verify the Borrower’s most recent two years of employment and income, and document using one of the following methods.

(1) Traditional Current Employment DocumentationThe Mortgagee must obtain the most recent pay stubs covering a minimum of 30 consecutive Days (if paid weekly or bi-weekly, pay stubs must cover a minimum of 28 consecutive Days) that show the Borrower’s year-to-date earnings, and one of the following to verify current employment:

  • a written Verification of Employment (VOE) covering two years; or
  • an electronic verification acceptable to FHA.

Re-verification of employment must be completed within 10 Days prior to the date of the Note. Verbal re-verification of employment is acceptable.

(2) Alternative Current Employment DocumentationIf using alternative documentation, the Mortgagee must:

  • obtain copies of the pay stubs covering the most recent 30 consecutive Days (if paid weekly or bi-weekly, pay stubs must cover a minimum of 28 consecutive Days) that show the Borrower’s year-to-date earnings;
  • obtain copies of the original IRS W-2 forms from the previous two years; and
  • document current employment by telephone, sign and date the verification documentation, and note the name, title, and telephone number of the person with whom employment was verified.

Re-verification of employment must be completed within 10 Days prior to the date of the Note. Verbal re-verification of employment is acceptable.

(3) Past Employment DocumentationDirect verification of the Borrower’s employment history for the previous two years is not required if all of the following conditions are met:

  • The current employer confirms a two year employment history, or a paystub reflects a hiring date.
  • Only base pay is used to qualify (no Overtime or Bonus Income).
  • The Borrower executes IRS Form 4506, Request for Copy of Tax Return,IRS Form 4506-T, Request for Transcript of Tax Return, or IRS Form 8821, Tax Information Authorization, for the previous two tax years.

If the applicant has not been employed with the same employer for the previous two years and/or not all conditions immediately above can be met, then the Mortgagee must obtain one or a combination of the following for the most recent two years to verify the applicant’s employment history:

  • W-2(s)
  • VOE(s)
  • electronic verification acceptable to FHA
  • evidence supporting enrollment in school or the military during the most recent two full years

iii. Primary Employment (Manual)

(A) DefinitionPrimary Employment is the Borrower’s principal employment, unless the income falls within a specific category identified below. Primary employment is generally full-time employment and may be either salaried or hourly.

(B) StandardThe Mortgagee may use primary Employment Income as Effective Income.

(C) Calculation of Effective Income

(1) SalaryFor employees who are salaried and whose income has been and will likely be consistently earned, the Mortgagee must use the current salary to calculate Effective Income.

(2) HourlyFor employees who are paid hourly, and whose hours do not vary, the Mortgagee must consider the Borrower’s current hourly rate to calculate Effective Income.For employees who are paid hourly and whose hours vary, the Mortgagee must average the income over the previous two years. If the Mortgagee can document an increase in pay rate the Mortgagee may use the most recent 12-month average of hours at the current pay rate.

iv.Part-Time Employment (Manual)

(A) DefinitionPart-Time Employment refers to employment that is not the Borrower’s primary employment and is generally performed for less than 40 hours per week.

(B) StandardThe Mortgagee may use Employment Income from Part-Time Employment as Effective Income if the Borrower has worked a part-time job uninterrupted for the past two years and the current position is reasonably likely to continue.

(C) Calculation of Effective IncomeThe Mortgagee must average the income over the previous two years. If the Mortgagee can document an increase in pay rate the Mortgagee may use a 12-month average of hours at the current pay rate.

v. Overtime and Bonus Income (Manual)

(A) DefinitionOvertime and Bonus Income refers to income that the Borrower receives in addition to the Borrower’s normal salary.

(B) StandardThe Mortgagee may use Overtime and Bonus Income as Effective Income if the Borrower has received this income for the past two years and it is reasonably likely to continue.Periods of Overtime and Bonus Income less than two years may be considered Effective Income if the Mortgagee documents that the Overtime and Bonus Income has been consistently earned over a period of not less than one year and is reasonably likely to continue.

(C) Calculation of Effective IncomeFor employees with Overtime or Bonus Income, the Mortgagee must average the income earned over the previous two years to calculate Effective Income. However, if the Overtime or Bonus Income from the current year decreases by 20 percent or more from the previous year, the Mortgagee must use the current year’s income.

vi. Seasonal Employment (Manual)

(A) DefinitionSeasonal Employment refers to employment that is not year round, regardless of the number of hours per week the Borrower works on the job.

(B) StandardThe Mortgagee may consider Employment Income from Seasonal Employment as Effective Income if the Borrower has worked the same line of work for the past two years and is reasonably likely to be rehired for the next season. The Mortgagee may consider unemployment income as Effective Income for those with Effective Income from Seasonal Employment.

(C) Required DocumentationFor seasonal employees with unemployment income, the Mortgagee must document the unemployment income for two full years and there must be reasonable assurance that this income will continue.

(D) Calculation of Effective IncomeFor employees with Employment Income from Seasonal Employment, the Mortgagee must average the income earned over the previous two full years to calculate Effective Income.

vii. Employer Housing Subsidy (Manual)

(A) DefinitionEmployer Housing Subsidy refers to employer-provided mortgage assistance.

(B) StandardThe Mortgagee may utilize Employer Housing Subsidy as Effective Income.

(C) Required DocumentationThe Mortgagee must verify and document the existence and the amount of the housing subsidy.

(D) Calculation of Effective IncomeFor employees receiving an Employer Housing Subsidy, the Mortgagee may add the Employer Housing Subsidy to the total Effective Income, but may not use it to offset the Mortgage Payment.

viii. Employed by Family-Owned Business (Manual)

(A) DefinitionFamily-Owned Business Income refers to Employment Income earned from a business owned by the Borrower’s family, but in which the Borrower is not an owner.

(B) StandardThe Mortgagee may consider Family-Owned Business Income as Effective Income if the Borrower is not an owner in the family-owned business.

(C) Required DocumentationThe Mortgagee must verify and document that the Borrower is not an owner in the family-owned business by using official business documents showing the ownership percentage.Official business documents include corporate resolutions or other business organizational documents, business tax returns or Schedule K-1(IRS Form 1065), U.S. Return of Partnership Income, or an official letter from a certified public accountant on their business letterhead.In addition to traditional or alternative documentation requirements, the Mortgagee must obtain copies of signed personal tax returns or tax transcripts.

(D) Calculation of Effective Income

(1) SalaryFor employees who are salaried and whose income has been and will likely continue to be consistently earned, the Mortgagee must use the current salary to calculate Effective Income.

(2) HourlyFor employees who are paid hourly, and whose hours do not vary, the Mortgagee must consider the Borrower’s current hourly rate to calculate Effective Income.For employees who are paid hourly and whose hours vary, the Mortgagee must average the income over the previous two years. If the Mortgagee can document an increase in pay rate the Mortgagee may use the most recent 12-month average of hours at the current pay rate.

ix. Commission Income (Manual)

(A) DefinitionCommission Income refers to income that is paid contingent upon the conducting of a business transaction or the performance of a service.

(B) StandardThe Mortgagee may use Commission Income as Effective Income if the Borrower earned the income for at least one year in the same or similar line of work and it is reasonably likely to continue.

(C) Required DocumentationFor Commission Income less than or equal to 25 percent of the Borrower’s total earnings, the Mortgagee must use traditional or alternative employment documentation.For Commission Income greater than 25 percent of the Borrower’s total earnings, the Mortgagee must obtain signed tax returns, including all applicable schedules, for the last two years. In lieu of signed tax returns from the Borrower, the Mortgagee may obtain a signed IRS Form 4506, Request for Copy of Tax Return, IRS Form 4506-T, Request for Transcript of Tax Return, or IRS Form 8821, Tax Information Authorization, and tax transcripts directly from the IRS.

(D) Calculation of Effective IncomeThe Mortgagee must calculate Effective Income for commission by using the lesser of (a) the average net Commission Income earned over the previous two years, or the length of time Commission Income has been earned if less than two years; or (b) the average net Commission Income earned over the previous one year. The Mortgagee must calculate net Commission Income by subtracting the unreimbursed business expenses from the gross Commission Income.The Mortgagee must reduce the Effective Income by the amount of any unreimbursed employee business expenses, as shown on the Borrower’s Schedule A. For information on analyzing the Borrower’s 1040, review Analyzing IRS Forms.

x. Self-Employment Income (Manual)

(A) DefinitionSelf-Employment Income refers to income generated by a business in which the Borrower has a 25 percent or greater ownership interest.There are four basic types of business structures. They include:

  • sole proprietorship;
  • corporations;
  • limited liability or “S” corporations; and

(B) Standard

(1) Minimum Length of Self-EmploymentThe Mortgagee may consider Self-Employment Income if the Borrower has been self-employed for at least two years.If the Borrower has been self-employed between one and two years, the Mortgagee may only consider the income as Effective Income if the Borrower was previously employed in the same line of work in which the Borrower is self-employed or in a related occupation for at least two years.

(2) Stability of Self-Employment IncomeIncome obtained from businesses with annual earnings that are stable or increasing is acceptable. If the income from businesses shows a greater than 20 percent decline in Effective Income over the analysis period, the Mortgagee must document that the business income is now stable.A Mortgagee may consider income as stable after a 20 percent reduction if the Mortgagee can document the reduction in income was the result of an extenuating circumstance, the Borrower can demonstrate the income has been stable or increasing for a minimum of 12 months, and the Borrower qualifies utilizing the reduced income.

(C) Required Documentation

(1) Individual and Business Tax ReturnsThe Mortgagee must obtain signed, completed individual and business federal income tax returns for the most recent two years, including all schedules.In lieu of signed individual or business tax returns from the Borrower, the Mortgagee may obtain a signed IRS Form 4506, Request for Copy of Tax Return, IRS Form 4506-T, Request for Transcript of Tax Return, or IRS Form 8821, Tax Information Authorization, and tax transcripts directly from the IRS.

(2) Profit & Loss Statements and Balance SheetsThe Mortgagee must obtain a year-to-date Profit and Loss (P&L) statement and balance sheet if more than a calendar quarter has elapsed since date of most recent calendar or fiscal year-end tax return was filed by the Borrower. A balance sheet is not required for self-employed Borrowers filing Schedule C income.If income used to qualify the Borrower exceeds the two year average of tax returns, an audited P&L or signed quarterly tax return obtained from the IRS is required.

(3) Business Credit ReportsThe Mortgagee must obtain a business credit report for all corporations and “S” corporations.

(D) Calculation of Effective IncomeThe Mortgagee must analyze the Borrower’s tax returns to determine gross Self-Employment Income. Requirements for analyzing self-employment documentation are found in Analyzing IRS Forms.The Mortgagee must calculate gross Self-Employment Income by using the lesser of:

  • the average gross Self- Employment Income earned over the previous two years; or
  • the average gross Self-Employment Income earned over the previous one year.

xi. Additional Required Analysis of Stability of Employment Income

(A) Frequent Changes in EmploymentIf the Borrower has changed employers more than three times in the previous 12-month period, or has changed lines of work, the Mortgagee must take additional steps to verify and document the stability of the Borrower’s Employment Income. Additional analysis is not required for fields of employment that regularly require a Borrower to work for various employers (such as Temp Companies or Union Trades). The Mortgagee must obtain:

  • transcripts of training and education demonstrating qualification for a new position; or
  • employment documentation evidencing continual increases in income and/or benefits.

(B) Addressing Gaps in EmploymentFor Borrowers with gaps in employment of six months or more (an extended absence), the Mortgagee may consider the Borrower’s current income as Effective Income if it can verify and document that:

  • the Borrower has been employed in the current job for at least six months at the time of case number assignment; and
  • a two year work history prior to the absence from employment using standard or alternative employment verification.

(C) Addressing Temporary Reduction in IncomeFor Borrowers with a temporary reduction of income due to a short-term disability or similar temporary leave, the Mortgagee may consider the Borrower’s current income as Effective Income, if it can verify and document that:

  • the Borrower intends to return to work;
  • the Borrower has the right to return to work; and
  • the Borrower qualifies for the Mortgage taking into account any reduction of income due to the circumstance.

For Borrowers returning to work before or at the time of the first Mortgage Payment due date, the Mortgagee may use the Borrower’s pre-leave income.

For Borrowers returning to work after the first Mortgage Payment due date, the Mortgagee may use the Borrower’s current income plus available surplus liquid asset Reserves, above and beyond any required Reserves, as an income supplement up to the amount of the Borrower’s pre-leave income. The amount of the monthly income supplement is the total amount of surplus Reserves divided by the number of months between the first payment due date and the Borrower’s intended date of return to work.

Required Documentation

The Mortgagee must provide the following documentation for Borrowers on temporary leave:

  • a written statement from the Borrower confirming the Borrower’s intent to return to work, and the intended date of return;
  • documentation generated by current employer confirming the Borrower’s eligibility to return to current employer after temporary leave; and
  • documentation of sufficient liquid assets, in accordance with Sources of Funds, used to supplement the Borrower’s income through intended date of return to work with current employer.

xii. Other Sources of Effective Income (Manual)

(A) Disability Benefits (Manual)

(1) DefinitionDisability Benefits refer to benefits received from the Social Security Administration (SSA), Department of Veterans Affairs (VA), or a private disability insurance provider.

(2) Required DocumentationThe Mortgagee must verify and document the Borrower’s receipt of benefits from the SSA, VA, or private disability insurance provider. The Mortgagee must obtain documentation that establishes award benefits to the Borrower.If any disability income is due to expire within three years from the date of mortgage application, that income cannot be used as Effective Income. If the Notice of Award or equivalent document does not have a defined expiration date, the Mortgagee may consider the income effective and reasonably likely to continue. The Mortgagee may not rely upon a pending or current re-evaluation of medical eligibility for benefit payments as evidence that the benefit payment is not reasonably likely to continue.Under no circumstance may the Mortgagee inquire into or request documentation concerning the nature of the disability or the medical condition of the Borrower.

(a) Social Security Disability (Manual)For Social Security Disability income, including Supplemental Security Income (SSI), the Mortgagee must obtain a copy of the last Notice of Award letter, or an equivalent document that establishes award benefits to the Borrower, and one of the following documents:

  • federal tax returns;
  • the most recent bank statement evidencing receipt of income from the SSA;
  • a Proof of Income Letter, also known as a “Budget Letter” or “Benefits Letter” that evidences income from the SSA; or
  • a copy of the Borrower’s form SSA-1099/1042S, Social Security Benefit Statement.

(b) VA DisabilityFor VA disability benefits, the Mortgagee must obtain from the Borrower a copy of the Veteran’s last Benefits Letter showing the amount of the assistance, and one of the following documents:

  • federal tax returns; or
  • the most recent bank statement evidencing receipt of income from the VA.

If the Benefits Letter does not have a defined expiration date, the Mortgagee may consider the income effective and reasonably likely to continue for at least three years.

(c) Private DisabilityFor private disability benefits, the Mortgagee must obtain documentation from the private disability insurance provider showing the amount of the assistance and the expiration date of the benefits, if any, and one of the following documents:

  • federal tax returns; or
  • the most recent bank statement evidencing receipt of income from the insurance provider.

(3) Calculation of Effective IncomeThe Mortgagee must use the most recent amount of benefits received to calculate Effective Income.

(B) Alimony, Child Support, and Maintenance Income (Manual)

(1) DefinitionAlimony, Child Support, and Maintenance Income refers to income received from a former spouse or partner or from a non-custodial parent of the Borrower's minor dependent.

(2) Required DocumentationThe Mortgagee must obtain a fully executed copy of the Borrower’s final divorce decree, legal separation agreement, court order, or voluntary payment agreement with documented receipt.When using a final divorce decree, legal separation agreement or court order, the Mortgagee must obtain evidence of receipt using deposits on bank statements; canceled checks; or documentation from the child support agency for the most recent three months that supports the amount used in qualifying.The Mortgagee must document the voluntary payment agreement with 12 months of canceled checks, deposit slips, or tax returns.The Mortgagee must provide evidence that the claimed income will continue for at least three years. The Mortgagee may use the front and pertinent pages of the divorce decree/settlement agreement and/or court order showing the financial details.

(3) Calculation of Effective IncomeWhen using a final divorce decree, legal separation agreement or court order, if the Borrower has received consistent Alimony, Child Support and Maintenance Income for the most recent three months, the Mortgagee may use the current payment to calculate Effective Income.When using evidence of voluntary payments, if the Borrower has received consistent Alimony, Child Support and Maintenance Income for the most recent six months, the Mortgagee may use the current payment to calculate Effective Income.If the Alimony, Child Support and Maintenance Income have not been consistently received for the most recent six months, the Mortgagee must use the average of the income received over the previous two years to calculate Effective Income. If Alimony, Child Support and Maintenance Income have been received for less than two years, the Mortgagee must use the average over the time of receipt.

(C) Military Income (Manual)

(1) DefinitionMilitary Income refers to income received by military personnel during their period of active, Reserve, or National Guard service, including:

  • base pay
  • Basic Allowance for Housing
  • clothing allowances
  • flight or hazard pay
  • Basic Allowance for Subsistence
  • proficiency pay

The Mortgagee may not use education benefits as Effective Income.

(2) Required DocumentationThe Mortgagee must obtain a copy of the Borrower’s military Leave and Earnings Statement (LES). The Mortgagee must verify the Expiration Term of Service date on the LES. If the Expiration Term of Service date is within the first 12 months of the Mortgage, Military Income may only be considered Effective Income if the Borrower represents their intent to continue military service.

(3) Calculation of Effective IncomeThe Mortgagee must use the current amount of Military Income received to calculate Effective Income.

(D) Mortgage Credit Certificates (Manual)

(1) DefinitionMortgage Credit Certificates refer to government Mortgage Payment subsidies other than Section 8 Homeownership Vouchers.

(2) Required DocumentationThe Mortgagee must verify and document that the Governmental Entity subsidizes the Borrower’s Mortgage Payments either through direct payments or tax rebates.

(3) Calculating Effective IncomeMortgage Credit Certificate income that is not used to directly offset the Mortgage Payment before calculating the qualifying ratios may be included as Effective Income. The Mortgagee must use the current subsidy rate to calculate the Effective Income.

(E) Section 8 Homeownership Vouchers (Manual)

(1) DefinitionSection 8 Homeownership Vouchers refer to housing subsidies received under the Housing Choice Voucher homeownership option from a Public Housing Agency (PHA).

(2) Required DocumentationThe Mortgagee must verify and document the Borrower’s receipt of the Housing Choice Voucher homeownership subsidies. The Mortgagee may consider that this income is reasonably likely to continue for three years.

(3) Calculation of Effective IncomeThe Mortgagee may only use Section 8 Homeownership Voucher subsidies as Effective Income if it is not used as an offset to the monthly Mortgage Payment. The Mortgagee must use the current subsidy rate to calculate the Effective Income.

(F) Other Public Assistance (Manual)

(1) DefinitionPublic Assistance refers to income received from government assistance programs.

(2) Required DocumentationMortgagees must verify and document the income received from the government agency.If any Public Assistance income is due to expire within three years from the date of mortgage application, that income cannot be used as Effective Income. If the documentation does not have a defined expiration date, the Mortgagee may consider the income effective and reasonably likely to continue.

(3) Calculation of Effective IncomeThe Mortgagee must use the current rate of Public Assistance received to calculate Effective Income.

(G) Automobile Allowances (Manual)

(1) DefinitionAutomobile Allowance refers to the funds provided by the Borrower’s employer for automobile related expenses.

(2) Required DocumentationThe Mortgagee must verify and document the Automobile Allowance received from the employer for the previous two years.The Mortgagee must also obtain IRS Form 2106, Employee Business Expenses, for the previous two years.

(3) Calculation of Effective IncomeThe Mortgagee must determine the portion of the allowance that can be considered Effective Income.The Mortgagee must subtract automobile expenses as shown on IRS Form 2106 from the Automobile Allowance before calculating Effective Income based on the current amount of the allowance received.If the Borrower uses the standard per-mile rate in calculating automobile expenses, as opposed to the actual cost method, the portion that the IRS considers depreciation may be added back to income. Expenses that must be treated as recurring debt include:

  • the Borrower’s monthly car payment; and
  • any loss resulting from the calculation of the difference between the actual expenditures and the expense account allowance.

Automobile Allowance refers to the amount of the Automobile Allowance that exceeds the Borrower’s actual automobile expenditures.

(H) Retirement Income (Manual)Retirement Income refers to income received from Pensions, 401(k) distributions, and Social Security.

(1) Social Security Income (Manual)

(a) DefinitionsSocial Security Income or Supplemental Security Income (SSI) refers to income received from the SSA other than disability income.

(b) Required DocumentationThe Mortgagee must verify and document the Borrower’s receipt of income from the SSA and that it is likely to continue for at least a three year period from the date of case number assignment.For SSI, the Mortgagee must obtain any one of the following documents:

  • federal tax returns;
  • the most recent bank statement evidencing receipt of income from the SSA;
  • a Proof of Income Letter, also known as a “Budget Letter” or “Benefits Letter” that evidences income from the SSA; or
  • a copy of the Borrower’s SSA Form-1099/1042S, Social Security Benefit Statement.

In addition to verification of income, the Mortgagee must document the continuance of this income by obtaining from the Borrower (1) a copy of the last Notice of Award letter which states the SSA’s determination on the Borrower’s eligibility for SSA income, or (2) equivalent documentation that establishes award benefits to the Borrower (equivalent document). If any income from the SSA is due to expire within three years from the date of case number assignment, that income may not be used for qualifying.

If the Notice of Award or equivalent document does not have a defined expiration date, the Mortgagee must consider the income effective and reasonably likely to continue. The Mortgagee may not request additional documentation from the Borrower to demonstrate continuance of Social Security Income.

If the Notice of Award letter or equivalent document specifies a future start date for receipt of income, this income may only be considered effective on the specified start date.

(c) Calculation of Effective IncomeThe Mortgagee must use the current amount of Social Security Income received to calculate Effective Income.

(2) Pension (Manual)

(a) DefinitionPension refers to income received from the Borrower’s former employer(s).

(b) Required DocumentationThe Mortgagee must verify and document the Borrower’s receipt of periodic payments from the Borrower’s Pension and that the payments are likely to continue for at least three years.The Mortgagee must obtain any one of the following documents:

  • federal tax returns;
  • the most recent bank statement evidencing receipt of income from the former employer; or
  • a copy of the Borrower’s Pension/retirement letter from the former employer.

(c) Calculation of Effective IncomeThe Mortgagee must use the current amount of Pension income received to calculate Effective Income.

(3) Individual Retirement Account and 401(k) (Manual)

(a) DefinitionIndividual Retirement Account (IRA)/401(k) Income refers to income received from an IRA.

(b) Required DocumentationThe Mortgagee must verify and document the Borrower’s receipt of recurring IRA/401(k) distribution Income and that it is reasonably likely to continue for three years.The Mortgagee must obtain the most recent IRA/401(k) statement and any one of the following documents:

  • federal tax returns; or
  • the most recent bank statement evidencing receipt of income.

(c) Calculation of Effective IncomeFor Borrowers with IRA/401(k) Income that has been and will be consistently received, the Mortgagee must use the current amount of IRA Income received to calculate Effective Income. For Borrowers with fluctuating IRA/401(k) Income, the Mortgagee must use the average of the IRA/401(k) Income received over the previous two years to calculate Effective Income. If IRA/401(k) Income has been received for less than two years, the Mortgagee must use the average over the time of receipt.

(I) Rental Income (Manual)

(1) DefinitionRental Income refers to income received or to be received from the subject Property or other real estate holdings.

(2) Rental Income Received from the Subject Property (Manual)

(a) StandardThe Mortgagee may consider Rental Income from existing and prospective tenants if documented in accordance with the following requirements.Rental Income from the subject Property may be considered Effective Income when the Property is a two- to four-unit dwelling, or an acceptable one- to four-unit Investment Property.

(b) Required DocumentationRequired documentation varies depending upon the length of time the Borrower has owned the Property.

(i) Limited or No History of Rental IncomeWhere the Borrower does not have a history of Rental Income from the subject since the previous tax filing:Two-to Four-UnitsThe Mortgagee must verify and document the proposed Rental Income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and the prospective leases if available.One UnitThe Mortgagee must verify and document the proposed Rental Income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report, Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, and Fannie Mae Form 216/Freddie Mac Form 998, Operating Income Statement, showing fair market rent and, if available, the prospective lease.

(ii) History of Rental IncomeWhere the Borrower has a history of Rental Income from the subject since the previous tax filing, the Mortgagee must verify and document the existing Rental Income by obtaining the existing lease, rental history over the previous 24 months that is free of unexplained gaps greater than three months (such gaps could be explained by student, seasonal or military renters, or property rehabilitation), and the Borrower’s most recent tax returns, including Schedule E, from the previous two years.For Properties with less than two years of Rental Income history, the Mortgagee must document the date of acquisition by providing the deed, Closing Disclosure or other legal document.

(c) Calculation of Effective IncomeThe Mortgagee must add the net subject property Rental Income to the Borrower’s gross income. The Mortgagee may not reduce the Borrower’s total Mortgage Payment by the net subject property Rental Income.

(i) Limited or No History of Rental IncomeTo calculate the Effective Income from the subject Property where the Borrower does not have a history of Rental Income from the subject Property since the previous tax filing, the Mortgagee must use the lesser of:

  • the monthly operating income reported on Freddie Mac Form 998; or
  • 75 percent of the lesser of:
    • fair market rent reported by the Appraiser; or
    • the rent reflected in the lease or other rental agreement.

(ii) History of Rental IncomeThe Mortgagee must calculate the Rental Income by averaging the amount shown on the Schedule E.Depreciation, mortgage interest, taxes, insurance and any HOA dues shown on Schedule E may be added back to the net income or loss.If the Property has been owned for less than two years, the Mortgagee must annualize the Rental Income for the length of time the Property has been owned.

(3) Rental Income from Other Real Estate Holdings (Manual)

(a) StandardRental Income from other real estate holdings may be considered Effective Income if the documentation requirements listed below are met. If Rental Income is being derived from the Property being vacated by the Borrower, the Borrower must be relocating to an area more than 100 miles from the Borrower’s current Principal Residence. The Mortgagee must obtain a lease agreement of at least one year’s duration after the Mortgage is closed and evidence of the payment of the security deposit or first month’s rent.

(b) Required Documentation

(i) Limited or No History of Rental IncomeWhere the Borrower does not have a history of Rental Income for the Property since the previous tax filing, including Property being vacated by the Borrower, the Mortgagee must obtain an appraisal evidencing market rent and that the Borrower has at least 25 percent equity in the Property. The appraisal is not required to be completed by an FHA Roster Appraiser.Two-to Four-UnitsThe Mortgagee must verify and document the proposed Rental Income by obtaining an appraisal showing fair market rent (use Fannie Mae Form 1025/Freddie Mac Form 72, Small Residential Income Property Appraisal Report) and the prospective leases if available.One UnitThe Mortgagee must verify and document the proposed Rental Income by obtaining a Fannie Mae Form 1004/Freddie Mac Form 70, Uniform Residential Appraisal Report, Fannie Mae Form 1007/Freddie Mac Form 1000, Single Family Comparable Rent Schedule, and Fannie Mae Form 216/Freddie Mac Form 998, Operating Income Statement, showing fair market rent and, if available, the prospective lease.

(ii) History of Rental IncomeThe Mortgagee must obtain the Borrower’s last two years’ tax returns with Schedule E.

(c) Calculation of Effective Net Rental Income

(i) Limited or No History of Rental IncomeTo calculate the effective net Rental Income from other real estate holdings where the Borrower does not have a history of Rental Income since the previous tax filing, the Mortgagee must deduct the PITI from the lesser of:

  • the monthly operating income reported on Freddie Mac Form 998, or
  • 75 percent of the lesser of:
    • fair market rent reported by the Appraiser; or
    • the rent reflected in the lease or other rental agreement.

(ii) History of Net Rental IncomeThe Mortgagee must calculate the net Rental Income by averaging the amount shown on the Schedule E provided the Borrower continues to own all Properties included on the Schedule E.Depreciation shown on Schedule E may be added back to the net income or loss.If the Property has been owned for less than two years, the Mortgagee must annualize the Rental Income for the length of time the Property has been owned.For Properties with less than two years of Rental Income history, the Mortgagee must document the date of acquisition by providing the deed, Closing Disclosure or other legal document.Positive net Rental Income must be added to the Borrower’s Effective Income. Negative net Rental Income must be included as a debt/liability.

(4) Boarders of the Subject Property (Manual)

(a) DefinitionBoarder refers to an individual renting space inside the Borrower’s Dwelling Unit.

(b) StandardRental Income from Boarders is only acceptable if the Borrower has a two-year history of receiving income from Boarders that is shown on the tax return and the Borrower is currently receiving Boarder income.

(c) Required DocumentationThe Mortgagee must obtain two years of the Borrower’s tax returns evidencing income from Boarders and the current lease.For purchase transactions, the Mortgagee must obtain a copy of the executed written agreement documenting their intent to continue boarding with the Borrower.

(d) Calculation of Effective IncomeThe Mortgagee must calculate the Effective Income by using the lesser of the two-year average or the current lease.

(J) Investment Income (Manual)

(1) DefinitionInvestment Income refers to interest and dividend income received from assets such as certificates of deposits, mutual funds, stocks, bonds, money markets, and savings and checking accounts.

(2) Required DocumentationThe Mortgagee must verify and document the Borrower’s Investment Income by obtaining tax returns for the previous two years and the most recent account statement.

(3) Calculation of Effective IncomeThe Mortgagee must calculate Investment Income by using the lesser of:

  • the average Investment Income earned over the previous two years; or
  • the average Investment Income earned over the previous one year.

The Mortgagee must subtract any of the assets used for the Borrower’s required funds to close to purchase the subject Property from the Borrower’s liquid assets prior to calculating any interest or dividend income.

(K) Capital Gains and Losses (Manual)

(1) DefinitionCapital Gains refer to a profit that results from a disposition of a capital asset, such as a stock, bond or real estate, where the amount realized on the disposition exceeds the purchase price.Capital Losses refer to a loss that results from a disposition of a capital asset, such as a stock, bond or real estate, where the amount realized on the disposition is less than the purchase price.

(2) StandardCapital gains or losses must be considered when determining Effective Income, when the individual has a constant turnover of assets resulting in gains or losses.

(3) Required DocumentationThree years’ tax returns are required to evaluate an earnings trend. If the trend:

  • results in a gain, it may be added as Effective Income; or
  • consistently shows a loss, it must be deducted from the total income.

(L) Expected Income (Manual)

(1) DefinitionExpected Income refers to income from cost-of-living adjustments, performance raises, a new job, or retirement that has not been, but will be received within 60 Days of mortgage closing.

(2) StandardThe Mortgagee may consider Expected Income as Effective Income except when Expected Income is to be derived from a family-owned business.

(3) Required DocumentationThe Mortgagee must verify and document the existence and amount of Expected Income with the employer in writing and that it is guaranteed to begin within 60 Days of mortgage closing. For expected Retirement Income, the Mortgagee must verify the amount and that it is guaranteed to begin within 60 Days of the mortgage closing.

(4) Calculation of Effective IncomeIncome is calculated in accordance with the standards for the type of income being received. The Mortgagee must also verify that the Borrower will have sufficient income or cash Reserves to support the Mortgage Payment and any other obligations between mortgage closing and the beginning of the receipt of the income.

(M) Trust Accounts (Manual)

(1) DefinitionTrust Income refers to income that is regularly distributed to a Borrower from a trust.

(2) Required DocumentationThe Mortgagee must verify and document the existence of the Trust Agreement or other trustee statement. The Mortgagee must also verify and document the frequency, duration, and amount of the distribution by obtaining a bank statement or transaction history from the bank.The Mortgagee must verify that regular payments will continue for at least the first three years of the mortgage term.

(3) Calculation of Effective IncomeThe Mortgagee must use the income based on the terms and conditions in the Trust Agreement or other trustee statement to calculate Effective Income.

(N) Annuities or Similar (Manual)

(1) DefinitionAnnuity Income refers to a fixed sum of money periodically paid to the Borrower from a source other than employment.

(2) Required DocumentationThe Mortgagee must verify and document the legal agreement establishing the annuity and guaranteeing the continuation of the annuity for the first three years of the Mortgage. The Mortgagee must also obtain a bank statement or a transaction history from a bank evidencing receipt of the annuity.

(3) Calculation of Effective IncomeThe Mortgagee must use the current rate of the annuity to calculate Effective Income.The Mortgagee must subtract any of the assets used for the Borrower’s required funds to close to purchase the subject Property from the Borrower’s liquid assets prior to calculating any Annuity Income.

(O) Notes Receivable Income (Manual)

(1) DefinitionNotes Receivable Income refers to income received by the Borrower as payee or holder in due course of a promissory Note or similar credit instrument.

(2) Required DocumentationThe Mortgagee must verify and document the existence of the Note. The Mortgagee must also verify and document that payments have been consistently received for the previous 12 months by obtaining tax returns, deposit slips or canceled checks and that such payments are guaranteed to continue for the first three years of the Mortgage.

(3) Calculation of Effective IncomeFor Borrowers who have been and will be receiving a consistent amount of Notes Receivable Income, the Mortgagee must use the current rate of income to calculate Effective Income. For Borrowers whose Notes Receivable Income fluctuates, the Mortgagee must use the average of the Notes Receivable Income received over the previous year to calculate Effective Income.

(P) Non-Taxable Income (Grossing Up) (Manual)

(1) DefinitionNon-Taxable Income refers to types of income not subject to federal taxes, which includes, but is not limited to:

  • some portion of Social Security Income;
  • some federal government employee Retirement Income;
  • Railroad Retirement benefits;
  • some state government Retirement Income;
  • certain types of disability and Public Assistance payments;
  • Child Support;
  • military allowances; and
  • other income that is documented as being exempt from federal income taxes.

(2) Required DocumentationThe Mortgagee must document and support the amount of income to be Grossed Up for any Non-Taxable Income source and the current tax rate applicable to the Borrower’s income that is being Grossed Up.

(3) Calculation of Effective IncomeThe amount of continuing tax savings attributed to Non-Taxable Income may be added to the Borrower’s gross income.The percentage of Non-Taxable Income that may be added cannot exceed the greater of 15 percent or the appropriate tax rate for the income amount, based on the Borrower’s tax rate for the previous year. If the Borrower was not required to file a federal tax return for the previous tax reporting period, the Mortgagee may Gross Up the Non-Taxable Income by 15 percent.The Mortgagee may not make any additional adjustments or allowances based on the number of the Borrower’s dependents.