How to calculate qualifying income? That phrase is uttered by many mortgage professionals, but the term is incorrect. The truth is many lenders focus on calculating income and fail to analyze the income. Aren’t they the same thing? Not really, and here is why. Calculating income is what you can do with your ubiquitous spreadsheet. You plug in the numbers from the income document; and voila, an income is calculated. Job done, right? Wrong. You have failed to analyze the income, and that involves a number of additional steps to confirm you can use the income you just calculated.
Income Analysis Basics
First, you must perform trend analysis year over year for each component of the income. You may have a solid base pay that is increasing each year, but the bonus and overtime may be declining. If it declines too much, you can’t use that income to qualify. Same goes for self-employed borrowers, you need to analyze the trends to ensure the business is healthy and not declining. Looking back in recent years there was a need to analyze profit and loss statements post COVID which was an analysis not previously performed.
Second, there are a number of supplemental calculations you must perform to support your income calculation. For self-employed income you will need to perform a cash flow analysis using the Form 1088. This isn’t an opinion or best practice, it is required by the agencies. Ref: Fannie Mae Selling Guide B3-3.2-01. Note how Fannie Mae refers to this as analysis of income, and not calculation. Furthermore, you also need to perform liquidity analysis, residual income analysis, and sufficiency analysis in some scenarios.
Lastly, performing a simple mathematical calculation only gets you the income amount and lacks the cross checking of income guidelines and income documentation requirements that must be met in order to use the qualifying income.
Alternatives
If you are using a spreadsheet, does it include all of these additional analyses? Are they performed on each and every loan? If so, good job, but sadly most lenders don’t have this level of analysis to back up their income calculations. So hopefully now you see the distinction we draw between income calculation and income analysis.
The risk you run in only doing income calculations are obvious, you run the risk of not being guideline compliant and potential loan buybacks. The benefit of doing the analysis you can reduce your risk of having an unsaleable loan by doing this work upfront, and on every loan.
My underwriters and processors have enough on their plate, I’m not sure how we can get them to do more analysis. Understood, but in reality you can’t afford not to. This is where as an operations leader the use of bespoke spreadsheets for income calculation need to be retired and dedicated income analysis tools, such as IncomeXpert need to be used.
Shifting Opinions
Lenders have shifted their opinions over time from a do-it-themselves most of the time, and using an income analysis tool for the hard loans; to a model where all loans go through the income analysis tool. Why? Lenders tell us that they want a consistent process and they see the value in doing all-the-analysis, all-the-time. No more judgment calls to determine when and if the full analysis treatment is given.
Tools like IncomeXpert make it easy for lenders to do all-the-analysis, all-of-the-time since the full set of calculations needed are run on each income type on every loan. It is an integrated system. Products like IncomeXpert PLUS make it even easier as it removes the manual data entry and automates the scanning and data extraction from the income documents.
In short, an income analysis should net you a report, not a single number. Getting the final qualifying income is good, but having the documented calculations, analysis, and supporting analysis to back up the qualifying income is what is really expected by the agencies.
New Trends
An emerging trend we see from clients who use IncomeXpert, is that income debates between sales and operations go way down as a result. Having a comprehensive income analysis report to justify a position leaves little room for subjectivity and debate. Net result, less confrontation and stress between sales and operations.
If you are curious about what guidelines are most frequently missed, we have compiled a report on the topic. Using our 3 million loans as a baseline, we have reviewed what guideline errors clients make most frequently. The report runs through the top five as well as suggestions for how to avoid these in the future. If you want a copy of the report, click the link below and we can email that to you.