Salary and Hourly Wages

When analyzing the stability of the current income for a salaried or wage earning employee, FHA underwriters examine the prior two years to assess the stability of the current income. If earnings are similar or increasing at a normal rate, they will most likely use the current base income. If income varies drastically they may choose to average the income.

In order to make the assessment, the FHA underwriter will – in most cases – require that the borrower provide his or her last two paystubs that show year-to-date earnings and his or her IRS form W-2s for the past two years. The underwriter will typically use the base employment of the borrower when calculating effective income.

Overtime and Bonus Income

Overtime and bonus income may be used to qualify if the borrower has received it for the past two years and it is likely to continue. FHA underwriters will use a two-year average of the overtime and/or bonus income for qualifying purposes. Further, a written verification of employment must be obtained from the borrower’s employer that states that the overtime and/or bonus is likely to continue. If this type of income has been received for less than two years, the FHA underwriter can use his or her judgment to use the income. However, the reasoning for doing so must be justified and documented in writing. In the event that bonus income varies significantly from year to year, a period of more than two years will be used in order to calculate the average income.

Part-time / Second Job Income

Part-time / second job income, including seasonal employment, may be used for qualifying purposes if it has been worked uninterrupted for the past two years and there is a strong likelihood that it will continue. Seasonal employment is considered uninterrupted if the borrower has worked the same type of job for the past two years and expects to be rehired during the next season. Some examples of this include umpiring baseball games in the summer, working as a tax preparer in the spring, or working as a department store clerk during the holiday shopping season. If this type of income has been received for less than two years, the FHA underwriter can use his or her judgment to use the income. However, the reasoning for doing so must be justified and documented in writing. This guideline refers to part-time income as a job taken to supplement the borrower’s income from regular employment as opposed to a primary job of less than 40 hours a week.

Commission Income

Commission income must be averaged over the previous two years. The borrower must provide copies of signed tax returns for the last two years, along with his or her most recent two paystubs with year-to-date earnings. If the borrower has unreimbursed business expenses, they must be subtracted from his or her gross income. If the borrower has commission income that has decreased from one year to the next, significant compensating factors are required for loan approval.

Retirement and Social Security Income

Retirement and social security income require verification from the source (former employer, Social Security Administration) or federal tax returns.

The FHA underwriter must be able to determine that the income will continue through the first full three years of the life of the loan.

Alimony, Child Support or Separate Maintenance Income

Income from these sources can be used for FHA qualifying purposes if the payments are likely to be consistently received for the first full three years of the life of the loan. The borrower must provide a copy of the final divorce decree, legal separation agreement, or voluntary payment agreement as well as evidence that the payments have been received during the past twelve months. This can be supported with documentation such as cancelled checks, deposit slips, tax returns and court records.

Interest and Dividends

Income from interest and dividends may be used as long as it can be supported with proper documentation to having been received for at least the past two year. The income must be averaged over the past two years. Acceptable documentation includes tax returns or account statements. If the borrower is withdrawing funds from the income source for purposes of cash investment in the home, the amount must be subtracted before projected interest or dividend income is calculated.

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 that the likelihood that it will continue is verified in writing.

Government Assistance Programs

Income received from government assistance programs is acceptable if supporting documentation is provided that shows that the income is expected to continue through at least the first three years of the life of the loan. These programs include unemployment income and section 8 homeownership vouchers.

Rental Income

Rental income from properties owned by the borrower is acceptable as long as the FHA underwriter can determine through provided documentation that the rental income is stable. Rent received from investment properties, or other units of an owner-occupied multifamily property, may be considered stable income. Rent from boarders in a single-family property that is also the borrower’s primary residence is not acceptable unless the boarder(s) are related by blood, marriage or law and the rental income is also shown on the borrower’s tax returns. Rent from a property that is the borrower’s second home is ineligible.

For documentation of rental income, FHA underwriters will require a Schedule E of IRS Form 1040 and current leases. The qualifying rental income is the net cash flow and it can be established by either the borrower’s most recent Schedule E, if the Borrower owned the property in the previous tax year or copies of the current lease agreement if the property was not owned in the previous tax year. Generally, the lease should have at least a 12-month term.

Schedule E of IRS form 1040 return

Make the following adjustments to the net income shown on Schedule E to determine the Net Cash Flow:

Net Income
+ Depreciation
– Unallowed losses (if any)
+ Loss carryovers from previous years (if any)
______________________________________
Annual Operating Income

Annual Operating Income/12 months = Monthly Operating Income

Monthly Operating income
– PITI for the property
_______________________
Net Cash Flow

Lease Agreements

Make the following adjustments to the rent stated on the lease agreement to determine the net cash flow:

Deduct a 25% maintenance expense/vacancy factor.
Subtract the PITI for the property.If the net cash flow is positive, include it in the qualifying income.
If net cash flow is negative, include it with the monthly liabilities.

Auto Allowance and Expense Account Payments

FHA will accept the only the portion automobile allowance income that exceeds related expenses for qualification purposes. The borrower must provide IRS form 2106 for the previous two years to establish the amount of income that may be added to gross income. In addition, the borrower’s employer must verify in writing that the payments will continue.

Trust Income

Income from trusts may be used if guaranteed, constant payments will continue through the first full three years of the life of the loan. Documentation required for FHA underwriting includes a copy of the Trust Agreement or other trustee’s statement that confirms the amount, frequency of distribution and duration of payments.