We have upgraded UberWriter with some new functionality. Read on in the blog as we weave some underwriting knowledge with some product update news.
One of the lessons I learned during my underwriting career is that the most likely reason a borrower defaults is due to their DTI. The DTI either starts off to excessive or becomes too excessive after the loan closes and they can no longer afford the subject property. Some of this is out of the hands of the lenders due to life changing circumstances like divorce, loss of job, or medical issues, but some of this is NOT out of the hands of lenders.
How much is enough?
The stunning lesson was how preventable this problem was. The key to prevention is the lender doing sufficient analysis of income. The next question is how much is enough! What I mean by enough analysis is that agencies require the underwriter to approve an income that is “most likely to continue”. They are not asking for the worst or most conservative income. By contrast they are not looking for the optimistic income to approve the loan either! So when you are calculating income, how do you know how much is enough?
The key concept here is called Income Trending Analysis. All agencies require it, but Fannie Mae does the best job explaining what is expected and their explanation is found in FNMA Guidelines B3-3.1-01 .
Before I continue on here, I want to let you know BEFORE it seems overwhelming. This is why we created UberWriter. We wanted to take the tedious calculations and ensure they are done consistently for every loan. No shortcuts. We have upgraded our income trending and warning logic for all our incomes. Our new and improved logic upgrades have added simple icons that SHOW you visually the trending analysis and will direct you to the RIGHT CHOICE on every income.
Now that you know there is an easy to use tool to do this for you, lets go over the agency requirements so you can understand what the agencies require!
Step 1: Determine when is trending needed
Determine if the income needs trending before you do all this work. Incomes like fixed base pay (i.e. salary), pensions, annuities, and military pay are not variable and therefore don’t need trending analysis. These sources of income typically don’t change from week to week, or month to month, so we aren’t required to do a trend analysis here.
Incomes that REQUIRE trending analysis are incomes of less predictable income sources including part-time hourly, self-employed , commissions, bonuses, substantial amounts of overtime pay, or employment that is subject to time limits, such as contract employees or tradesmen.
So now we know what types of income sources need this trending analysis, let’s dig into how to calculate it.
Step 2: Determine the trend of income
A proper trending analysis will show the following three outcomes for each individual income source (base pay, overtime, bonus, etc)
- Income is stable or increasing (Green UP arrow in UberWriter)
- Income that was declining but is NOW stable or increasing (Yellow UP arrow In UberWriter)
- Income that is declining (Red DOWN arrow in UberWrtier)
To determine the income trend, we first must determine the percent change from each adjacent year. We do this for each individual income source. To calculate the percent change between two years (Y1 and Y2), use this formula.
% change = (Y1 – Y2) / Y2 * 100
For the next three examples assume we have a VOE or VOI dated 06/30/2019 and overtime shows the following. We chose this date of the VOE or VOI to give us an even 6 months to simplify the math.
Example 1
$6,000 2019 YTD = $1,000 Per month for 2019
$11,000 2018 YTD = $917 Per month for 2018
$10,000 2017 YTD = $833 Per month for 2017
% of change for each year
10% increase 2017 to 2018
9.1% increase 2018 to 2019 YTD
Conclusion income is “stable or increasing”
Example 2
$6,000 2019 YTD = $1,000 Per month for 2019
$9,000 2018 YTD = $750 Per month for 2018
$15,000 2017 YTD = $1,250 Per month for 2017
% of change for each year
40% decrease 2017 to 2018
33% increase 2018 to 2019 YTD
Conclusion income is “was decreasing but now stable or increasing”
Example 3
$3,000 2019 YTD = $500 Per month for 2019
$9,000 2018 YTD = $750 Per month for 2018
$15,000 2017 YTD = $1,250 Per month for 2017
% of change for each year
40% decrease 2017 to 2018
33% decrease 2018 to 2019 YTD
Conclusion income is “decreasing”
Step 3: Choose the “Most Likely To Continue” income
Now that you have calculated the trending history, you can give a much better answer on which income is most likely to continue. Here is the math required to finish up the process (keep in mind VOE/VOI dated 06/30/2019 in our example):
For income that is stable or increasing take the lowest of these three:
- 2019 YTD / 12 months. This is called annualizing the income. This assumes the current YTD income will likely continue for the rest of the year.
- 2019 YTD / 6 months. This is the actual monthly income averaged over the months to date in the year.
- 2018 YTD + 2018 / 18 months. This is averaging the income across the YTD and the prior tax year.
The reason I advise to take the lowest is that the minimum is most likely to continue. If a person’s income is going up we must allow them enough time to show it is not a fluke or spike in pay.
For income that was declining but now is stable or increasing take the lowest of these two incomes:
- 2019 YTD / 6 months. This is the actual monthly income averaged over the months to date in the year.
- 2019 YTD + 2018 / 18 months. This is a longer term on the average and includes the prior tax year. This is a good conservative choice if the 2018 decline was large.
The reason we don’t add in 2017 at all is that was an inflated income year. Adding in the 2017 income inflation pushes the borrowers calculated income higher than their current earning reality.
For income that is declining take the lowest of these two incomes:
- $0 per month. Since the income is declining it is not likely to continue
- 2019 YTD / 6 months
NOTE on option B this is an EXCEPTION, you must in writing justify to the agency or lender why you are confident that the income presented will not decline any lower that the number determined on option B.
What is stable income?
The guidelines call qualified income as stable or increasing. Increasing income is easy enough to understand but what is stable? Most lenders / agencies do not expect a perfect situation where the borrower’s income goes up and up and up. So some decrease is allowed. The problem is the agencies don’t outline what is an acceptable decline. Here is my advice. For variable income pick a company standard tolerance. The key to this is a COMPANY standard. This should not be each underwriter has their own threshold. Start with a conservative number like 10%. Next, monitor your QC. Adjust the number up or down based on your QC results. Monitor to see what number gives you an audit failure or a buy back from your investor. I know this sounds pretty risky but it is the best way to develop data to support your company risk tolerance level. The only other option is to create one (like 10%) that is conservative and stick with it.
When calculating income trending watch for year over year trends AND overall trends. The 10% tolerance tax should be observed between 2018 and 2019 OR if the tolerance is broken between 2017-2019 YTD. Either one is a red flag (quick decline versus slow decline but the outcome is the same).
Simple right??? I know this requires more work and time from your operations department but it is the only way to give your borrowers the best customer service. Having consistent income calculations with consistent standards creates wise decision making!
As I mentioned, using UberWriter all of these income calculations are done for you instantly and automatically! So while many may say they don’t need a tool to help them calculate hourly borrower income, when you consider all of the analysis you need to do a tool starts making sense for speed, consistency, and risk management.
Go to www.blueprintio.wpengine.com for more information and if you want a free account
One Response
Great article, thanks!