Compliance with income guidelines matter
We all tolerate rules until those rules stop us from getting what we want. Many of us are probably guilty of being speeders on the nation’s highways. Every now and then we might get a speeding ticket. But a small number of people may speed and cause collisions. Speeding, tickets, and collisions is a metaphor for following underwriting rules. Sure, you can break the rules since only a fraction of the loans are audited, but every now and then a borrower defaults and if you didn’t follow the rules in determining the income the buyback is on you.
When you are talking about compliance (i.e. rules & guidelines) for income there are three categories
- The rules explaining when you can and can’t use income of any type
- The rules explaining how to calculate an income
- The rules explaining how to determine if the income is stable
Rules when you can use income
One of the phases we often use in explaining underwriting rules is “Just because two plus two equals four, does not mean four is the right answer”. For some incomes the math is the easy part. The tricky area is determining IF you can use that income to start with.
A common example of this is when your borrower has overtime that just started two months ago, and they have no history of ever getting overtime. That overtime income is not qualified for mortgages with any investor.
In addition overtime income, there are many other rules across employed and self-employed incomes that will control if you can use an income or not. Knowing, much less memorizing and correctly applying these rules across multiple agencies is a daunting task for most underwriters.
This first set of rules is key to a good income review of a loan submission, too many mortgage professionals go right to the math before knowing if the income qualifies regardless of how the math works out.
Rules to determine the income
Once you know if you can use an income, next is knowing what income components to add and subtract comes into play. The biggest differences in income calculations are between the conforming agencies (Fannie & Freddie) and government agencies (FHA, VA, USDA). This problem often shows up in underwriting audits when a borrower changes from a conforming loan to a government sponsored loan (i.e. FNMA to FHA). The underwriter will have so much to do they may forget to recalculate the income using the new agency’s rules.
For example the method that FHA uses to calculate rental income derived from properties other then the subject property are different than the Fannie Mae and Freddie Mac method.
Another area that hangs up many underwriters is the “IF/THEN” rules. These rules are found quite a bit in the self employed borrowers. A common example is on the 1065 /1120S/1120 tax forms, they have a balance sheet called the Schedule L. If the borrower’s business has a mortgage / note / bond due in less than one year it creates an “IF/THEN” rule. The rule which is IF the borrower has a note due in under one year and IF the Schedule L does not show enough funds in line 1D THEN the borrower must subtract the loan amount from the personal income. But IF the borrower can provide evidence that the loan rolls over , then the deduction is not required. Easy to follow right??
As we mentioned in the prior section there are numerous instances in addition to the example above leading to quite a bit of memorization for underwriters.
Rules to determine if the income is stable
Thus far you have determined if you can use the income, how to calculate the income, lastly we can analyze the income to determine if it is stable. We go into more detail about income trending analysis elsewhere.
The stability rules (called trending analysis in the guidelines) show the underwriter what is considered sufficient analysis for each agency to determine that key element of stability.
These rules look like this:
- Calculate what the borrower SHOULD be making
- Calculate what they ARE making
- Calculate what they HAVE BEEN making for the last 1-2 years (depending on the type of income).
At this point the underwriter must compare all three, look for a trend, then follow the written trending rules. The trending rules outline what to do if the income is increasing or stable (or said as “slightly decreasing”), what if it declining but now recovered, and what if is just declining. Each one of those vectors have different rules to follow.
Pulling it all together
Now that you have a quick outline of what the agencies require from lenders, it may cause you to pause and think about what your company is doing in the underwriting process. The typical mortgage company relies heavily on the expertise of their mortgage underwriters to make sure the income meets all three sets of rules. But what if you have a small team and that one underwriter leaves (or is on vacation)… then what?
We suggest something more dynamic and reliable besides human memory. We suggest implementing a system for underwriting income as part of your workflow. The advantages of the system are numerous!
IncomeXpert is that system…
- Knows all the agency income guidelines and checks them on every loan
- Knows what can be included or excluded from the income based on agency guidelines
- Knows the requirements for an income trending analysis, to get the proper final income
Let us help your team get on board with a complete income system that completes tens of thousands of income calculations for lenders every month.