If some of you have been following my blogs you know that outside of my “underwriting world” I am private pilot here in Michigan.

One of the terms I have learned between my private pilot rating and my instrument training is when you get really close to a VOR (a ground navigation beacon) your instrument that detects the VOR’s location goes “crazy”.  When that happens, you know you are above the VOR on the ground since it was not designed to “transmit” straight above it’s location.  The further you are away from the beacon makes it more an more accurate because that is how it was designed!   The lesson we can apply to underwriting is in January you may be confused on the reading of the Year To Date Income… but that does NOT mean you should be confused on what the borrowers income is!

The issue I am talking about is the year to date (YTD) calculations get all jumbled up and show CRAZY high amounts of income per month in the fist few weeks in the year.  For example, I have seen people who make $5,000 month look like they earn $35,000 per month due to the year to date calculation “confusion” reported in January.  Over the years I have learned to ignore it because I know what the borrower makes (which is lower).   This my friend is “The Income Zone Of Confusion”.

Example:
$25.00 per hour is earned by the borrower and the borrower is paid either weekly OR Bi- Weekly (this will not happen on Semi Monthly OR Monthly paid employees)
The borrowers earns income in the last one or two weeks of December
The pay period for those last few days of December income is NOT paid out until January pay date of the following year

What we know
$4,333.33 is what the borrower should earn if they earn $25 x and work 40hrs per week

Year To Date Calculation Example but the income shows $15,384.62 per month??
$2,000 is paid on the first January paystub, lets say that date is January 4th.
The standard way we get the denominator to determine “Average” pay per month is taking the full amount of lapsed months PLUS the changing the pay period calander day into a decimal. For example January 4th would turn into the denominator  0.13 months.  ( Full months elapsed = 0  + days elapsed 4 in January / 31 days in January = .13 months).  NOW take $2,000 / .13 months YTD elapsed =  $15,384.62  Per Month Earnings!!!

Said in another way is IF the borrower keeps earning $2,000 every 4 days they would IN FACT earn $15,384.62 per month!

WHAT??? The borrower does NOT earn $15,384.62 per month base pay!!! What is wrong here??

How to overcome the zone of confusion.
The zone of confusion ONLY happens when you try to use the YTD income in such a short period of time.  Most income CAN NOT be calculated looking at a period of time under one year MUCH LESS under one month.  As I said earlier with the VOR beacon, the further out you are from the beacon the more accurate is becomes (up to about 40+ miles for you fellow pilots).  This same thing is true about income, you want to be at LEAST 18-24 months to get an average, but legally you can use a minimum of one year.  I would suggest you do the following

Average the year to date + most recent year income (the means your income will be the minimum of “just over” one year)
Average the year to date + most recent year income + previous year income (the means the income will be “just over” two years)

Again the father you are from the point in time the better an average will be.  Many jobs have “High’s and Lows” in their income.  Think of the mortgage business, would it be fair to say you earn the same amount of money per month in June as you do in January?  No , you would want to see two “full years” to see what an income trend is to make sure you have a TRUE average!

Last tip keep in mind, when you are working on a borrowers “base pay” and they work steady hours you ONLY use the averaging method to confirm they are in fact working a steady amount of time.  BUT for any other variable income (Variable base hours, overtime, bonus, commission, tips, etc) this information becomes vital!

Bottom line…  the zone of confusion will loose it’s craziness if you just keep in mind “where on the map” you are!