One of the basic requirements from both FNMA and FHLMC is for the underwriter to determine the stability of the income used to qualify. This is where the concept of continuance comes in. Sometimes I know the readers of this blog like to go deep into subjects like K-1 income or what can you use instead of distributions to support the K-1 income, but let us not forget about underwriting 101!
Income Stability Rules
In my training the 10 point underwriting process step 3 is the income evaluation step. In this step I teach that all income must meet the following four statements:
- Income must show stability to qualify
- Income must continue 36 months after closing to qualify
- Income must have a have a history to qualify
- Income must have documentation to qualify
To be honest, most mortgage professionals don’t really struggle with the rules of “how long should my borrower be on the job”. But amazingly enough I do get a fair amount of questions on things like alimony, child support, dividend income, or some forms of social security income. The questions are always things like “how long do that have to receive a dividend before I can use it?” or “Is the 36 month rule applied from application date or the closing date”.
Well there is an easy way in one spot to get these 4 key statements answered and as an underwriter and to know what documents to ask for! FHLMC 5301.1: General requirements for all stable monthly income updated last on (07/06/17) shows us the A, B, C’s of income continuance and what we need to do to use these forms of income.
Income Continuance Breakdown
Chart Section A
Income and earnings types typically without documentable continuance
This section contains the majority of the income types we deal with on a daily basis.
Examples of income without documentable continuance:
- Overtime
- Bonus
- Auto Allowance
- Fluctuating Pay
- Self Employed Income
FHLMC Provides this guidance:
Income must be likely to continue for at least the next three years. The Seller is not required to obtain documentation to verify income continuance, absent any knowledge, information or documentation that the income is no longer being received or is likely to cease.
Chart Section B
Income types with documentable continuance
This section has the income that are commonly known to have a start date and finish date on them!
Examples off income with documented continuance:
- Child support
- Alimony
- Interest
- Royalty Payments
FHLMC Provides this guidance:
For income types with documentable continuance, the documentation requirements for each individual income type listed within Topic 5300 provide the minimum documentation required in order for the Seller to verify income continuance for at least three years.
Chart Section C
Income types that may or may not have documentable continuance
This section is the hardest section to deal with. I have often said that being an underwriter you have to be a “Jack of All Trades” in the financial world. You need a basic understanding of quite a few financial vehicles, insurance programs, and over all “how this guy get paid” thought process!
Examples of income that may not have documented continuance:
- Long term disability
- Short term disability
- Supplemental SS income
- Public Assistance Income
FHLMC Provides this guidance:
Certain income types are comprised of multiple income sources, each of which may have specific requirements with respect to continuance, whether defined or undefined. For this reason, this grouping of income types may or may not have documentable continuance. For example, if the source of retirement income is Social Security retirement benefits, no additional documentation of continuance is required; however, if the source is a retirement annuity from an insurance company, there will generally be a defined term in which case continuance must be documented.
Well that is it for this week’s blog! I did want to tell you we are just a few more weeks away from some exciting additional resources for underwriting education. Stay tuned for more on these new tools launching in September!
5 Responses
Hi Michael ,
How do we serve a client that is taking a new job in the same field (i.e. School teacher) with 13 years of previous experience as a teacher and has not received their first paycheck from their new job? Is their contract with the new employer enough to Bridge a one month gap instead he pay?
Hi Paul
Very sorry for the delay in this reponse, assuming your borrower has a solid two year work history it sounds like you could this guideline from FNMA. FNMA B3-3.1-09 Other Sources of income, under employment offers and contracts, take a look at that section see if that helps!
Thanks
Michael
Hello Michael,
I have been approved for several loans from different lenders under these guidelines where I have established a regular distribution from a brokerage account (not a retirement account) in which there are sufficient funds to maintain the distribution for 36 months or more.
However, where the prospective lender is a Wells Fargo, CITI or smiliar institution they insist that the funds must come from a Retirement account. Do they legally have the discretion to do this? For some properties these institutions may be the only lender available.
Hi Ed
The banks your referring to are sellers to FNMA and FHLMC, so they do follow their (FNMA / FHLMC) guidelines for lending and the issue your talking about is “legal” to consider. That being said the rule they are talking about and must follow to sell that loan to the agencies is called Employment- Related Assets as Qualifying income (FNMA B3-3-1-09 other income) and it says the following….
Employment-Related Assets as Qualifying Income
The following table provides the requirements for employment-related assets that may be used as qualifying income.
✓ Asset Requirements
Assets used for the calculation of the monthly income stream must be owned individually by the borrower, or the co-owner of the assets must be a co-borrower of the mortgage loan.
The documentation must be in compliance with the Allowable Age of Credit Documents policy (see B1-1-03, Allowable Age of Credit Documents and Federal Income Tax Returns, for additional information).
Assets must be liquid and available to the borrower and must be sourced as one of the following:
A non-self-employed severance package or non-self-employed lump sum retirement package (a lump sum distribution) — these funds must be documented with a distribution letter from the employer (Form 1099–R) and deposited to a verified asset account.
For 401(k) or IRA, SEP, Keogh retirement accounts – the borrower must have unrestricted access to the funds in the accounts and can only use the accounts if distribution is not already set up or the distribution amount is not enough to qualify. The account and its asset composition must be documented with the most recent monthly, quarterly, or annual statement.
If a penalty would apply to a distribution of funds from the account made at the time of calculation, then the amount of such penalty applicable to a complete distribution from the account (after costs for the transaction) must be subtracted to determine the income stream from these assets.
If the employment–related assets are in the form of stocks, bonds, and mutual funds, 70% of the value (remaining after costs for the transaction and consideration of any penalty) must be used to determine the income stream to account for the volatile nature of these assets.
A borrower shall only be considered to have unrestricted access to a 401(k) or IRA, SEP, Keogh retirement account if the borrower has, as of the time of calculation, the unqualified and unlimited right to request a distribution of all funds in the account (regardless of any possible tax withholding or applicable penalty applied to such distribution).
How do you document 3 year continuance for royalties ( Gas & Oil)