The anticipated amount of income, and likelihood of its continuance, must be established. Income from any source that cannot be verified, is not stable, or will not continue cannot be used in calculating the borrower’s income ratios. This paragraph describes acceptable types of income, procedures for calculating effective income, and requirements for establishing income stability.
| 1. | While HUD does not impose an eligibility requirement of a minimum length of time a borrower must have held a position, the lender must verify the most recent two full years’ worth of employment. If a borrower’s employment history indicates participation in school or in the military during any of this time, the borrower must provide supporting evidence (usually college transcripts or discharge papers). |
| 2. | The borrower must also explain any gaps in employment of a month or more. Such gaps are not necessarily cause for loan disapproval. Allowances for seasonal employment, such as is typical in the fishing industry, should be made. |
| 3. | In some cases, a borrower may have recently returned to the work force after an extended absence. In these circumstances, the borrower’s income may be considered effective and stable provided: |
| § | The borrower has been employed in the current job for six months or more; and |
| § | The borrower can document a two-year work history prior to the absence from the work force. This can be accomplished by providing traditional employment verifications, copies of W-2’s, etc. |
An example of an acceptable employment situation includes a nurse that took several years off to raise children and is now returning to the nursing profession. Scenarios not meeting the criteria above should be considered as compensating factors only.
| 4. | To analyze the probability of continued employment, lenders must examine the borrower’s past employment record, qualifications for the position, previous training and education, and the employer’s confirmation of continued employment. A borrower who changes jobs frequently within the same line of work, but continues to advance in income, may be considered favorably. |
| b. | Salaries, Wages, and Other Forms of Income. The income of each borrower to be obligated for the mortgage debt must be analyzed to determine whether it can be expected to continue through the first three years of the mortgage loan. If the borrower intends to retire during this period, the effective income will be the amount, for example, of retirement benefits or social security payments. No inquiry may be made regarding possible future maternity leave. |
In most cases, borrower income will come primarily from salaries or wages (whether from full or part time employment). However, income from most other sources, provided it is properly verified by the lender, also can be included as income. Procedures for treating other acceptable income sources are described below. Sources of income not meeting the criteria for documentation of income may be considered as a compensating factor (see Paragraph 5.8b).
| 1. | Overtime and Bonus Income. Overtime and bonus income may be counted as effective income if the borrower has received such income for the past two years and there are reasonable prospects of its continuance. Periods of less than two years may be acceptable provided the lender adequately justifies and documents his or her reason for using the income for qualifying purposes. The lender must adequately document the file and justify his or her reasons for using the income for qualifying purposes. Only if the employment verification specifically states that bonus or overtime is not likely to continue may that income not be considered in the qualifying ratio. An earnings trend over the period of receipt should be analyzed for either source of income. If either type of income shows a continual decline, the lender must provide a sound rationalization for including the income as effective income. |
| 2. | Seasonal Income. Income from seasonal employment may be counted if the borrower can show a history of seasonal income for at least two years, and expects to be rehired during the next season. Unemployment income expected to be received for some period of the "off season" may be counted if the borrower has received it for the past two years and there is reasonable assurance of its continuance. This may be appropriate for individuals employed on a seasonal basis, such as farm workers or fishing crews. |
HUD recognizes that many Native American families rely on seasonal income. Lenders must not arbitrarily restrict the consideration of such income sources in qualifying borrowers.
| 3. | Part-Time Income. Borrowers are likely to have two types of part-time employment: (1) regular, part-time employment which is the borrower’s primary source of income (e.g., a nurse who regularly works 24 hours/week) and (2) part-time employment which supplements the borrower’s regular sources of income. Income from regular part-time employment can be counted as effective income if its receipt can be documented and is expected to continue. The criteria for the analysis of such regular part-time income are identical to those used for full-time wages and salaries. Income from supplementary part-time income may be counted if the borrower has worked the part-time job for the past 2 years and will continue to do so. |
| 4. | Commission Income. Commission income must be averaged over the previous two years. The borrower must provide tax returns from the previous two years and a recent pay stub. (Business expenses not reimbursed must be subtracted from gross income.) |
Commissions earned within less than one year are not considered income. Exceptions may be made when the borrower’s compensation changed from a salary to commission for a similar position with the same employer.
| 5. | Retirement and Social Security Income. Such income requires verification from the source (e.g., former employer, Social Security Administration) or through federal tax returns. Any benefits that will expire within the first three years of the mortgage may not be considered income but may be used as a compensating factor. |
| 6. | Alimony, Child Support, or Maintenance Payments. Income in this category may be considered if such payments are likely to be consistently received for the first three years of the mortgage. The borrower must provide a copy of the divorce decree or legal separation agreement and evidence that payments have been made during the past 12 months. Acceptable evidence of regularity of payments includes cancelled checks, deposit slips, tax returns, or court records. Periods of less than 12 months maybe acceptable provided the payer’s ability and willingness to make timely payments can be documented by the lender. |
| 7. | Notes Receivable. A copy of the note must be presented to establish the amount and length of payment. The borrower must also provide evidence, which may include deposit slips, cancelled checks, or tax returns that payments have been received consistently for the previous 12 months. |
| 8. | Interest and Dividends. Interest and dividend income may be used provided documentation (tax returns or account statements) supports a two-year history of receipt. This income must be averaged over the two years. Any funds derived from these sources and required for the cash investment must be subtracted before the projected interest or dividend income is calculated. |
| 9. | VA Benefits. Direct compensation verified by the VA, such as for a service-related disability, is considered income. Education benefits used to offset education expenses are not considered income. |
| 10. | Government Assistance Programs. Assistance income (e.g., welfare, workman’s compensation, or payments for foster children) is considered income subject to documentation from the paying agency provided the income is expected to continue for the first three years of the mortgage. If not expected to last the first three years, the income is considered a compensating factor. |
| 11. | Net Rental Income. Rent received for other properties owned by the borrower may be counted as income, assuming proper documentation such as tax returns is submitted. Income from roommates, or sub-leasers in a single-family property to be occupied as the borrower’s primary residence, is not considered income. |
| § | Schedule E of IRS form 1040. Depreciation should be added back into the net income or loss shown on Schedule E. Positive rental income is considered as gross income for qualifying purposes. Negative rental income must be treated as a recurring liability. The lender must make certain the borrower still owns each property listed by comparing the Schedule E with the real estate owned section of the application. |
| § | Current leases. If a property was acquired since the last income tax filing and/or is not shown on the Schedule E, a current, signed lease or other rental agreement must be provided. The gross rental amount must be reduced for vacancies and maintenance by the percentage developed by the HUD area office before subtracting principal, interest, taxes, insurance, etc. |
| 12. | Trust Income. Income from trusts may be used if guaranteed, constant payment will continue for the first three years of the mortgage. Documentation requirements include a copy of the Trust Agreement or other trustee’s statement confirming the amount, frequency of distribution, and duration of payments. Funds from the trust account with adequate documentation may also be used for the required cash investment. |
Both the tribes and individual tribal members may have income derived from sources such as timber sales on trust lands, lease payments from trust lands, or fishing income derived from usual and accustomed fishing grounds. Such income is not reported through normal tax reporting methods. Lenders can obtain verification through the local BIA offices or through tribal documentation and records.
| 13. | Nontaxable Income. If a particular source of income is not subject to federal taxes (e.g., certain types of disability payments, military allowances, income derived from the reservation land), the amount of continuing tax savings attributable to the nontaxable income source may be added to the borrower’s gross income. The percentage of income that may be added may not exceed the appropriate tax rate for that income amount, and no additional allowances for dependents are acceptable. The lender must document and support the adjustments made (i.e., the amount the income is "grossed up") for any nontaxable income source. |
| 14. | Projected Income. Except for those situations described below, projected or hypothetical income is not acceptable for qualifying purposes. Exceptions are permitted for such income as cost-of-living adjustments, performance raises, or bonuses, which are verified by the employer and scheduled to begin within 60 days of loan closing. |
For those borrowers about to start a new job, if the borrower has a guaranteed, irrevocable contract for the new employment that will begin within 60 days of loan closing, the income is acceptable for qualifying purposes. The lender must also verify that the borrower will have sufficient income or cash reserves to support the mortgage payments and any other obligations during the interim between loan closing and the start of employment. (This may be appropriate for situations such as a teacher whose contract begins with the new school year or a physician beginning residency after the loan is scheduled to close.) However, if the loan will close more than 60 days before the employment begins, the loan is not eligible for guarantee until the lender provides a pay stub or other acceptable evidence that the borrower has actually begun the new job.
| 15. | Tribal Distributions. In certain areas, tribal members receive per capita payments. If these payments can reasonably be expected to continue for the first three years of the mortgage, they may be counted as income. A 2-year history of receipt is required and the lesser of the current per capita payment or 2-year average will be used for income purposes. For new sources of tribal distribution that do not have a past history, the tribe must certify that payments will continue for at least three years. |
| 16. | Military Income. In addition to base pay, military personnel may be entitled to additional forms of pay. Income from variable housing allowances, clothing allowances, flight or hazard pay, rations, and proficiency pay may be counted provided its continuance is verified. |
| 17. | Other. Several other types of income that are typically excluded from income for other federal programs may be included for the purposes of the Section 184 Guarantee. These items include: |
| § | The per capita shares received from judgment funds awarded by the Indian Claims Commission or the Court of Claims (25 U.S.C. 1407–1408) or from funds held in trust for an Indian tribe by the Secretary of Interior (25 U.S.C. 117). |
| § | Payments received under the Alaska Native Claims Settlement Act (43 U.S.C. 1626(a)). |
| § | Income derived from the disposition of funds of the Grand River Band of Ottawa Indians. |
| § | Payments received under the Maine Indian Claims Settlement Act of 1980. |
| 18. | Employment By Family-Owned Businesses. Borrowers employed by businesses owned by family members must provide normal verification of employment and pay stubs, as well as evidence that the borrower is not an owner of the business. This may include copies of the borrower’s signed personal tax returns or a signed copy of the corporate tax return showing ownership percentages or a signed certified statement by the corporation or business accountant. |
| 19. | Self-Employed Borrowers. A borrower with ownership interest in a business of 25 percent or more is considered self-employed for mortgage loan underwriting purposes. |
| § | Analyzing Income. The lender must establish the borrower’s earnings trend over the previous two years, but may average the income over three years if all three years’ tax returns are provided. In addition, the income shown on the year-to-date profit-and-loss statement may be included in determining average income if it is consistent with the previous years’ earnings. |
Lenders must carefully analyze the individual business’ financial strength, the source of its income, and the general economic outlook for similar businesses in that area to determine if the business can be expected to continue to generate sufficient income to meet the borrower’s needs. Annual earnings that are stable or increasing are acceptable. Conversely, a borrower whose business shows significant decline in income over the period analyzed may not qualify even if the current debt to income ratio meets the Section 184 guideline.
| § | Minimum Length of Self-Employment. Income from self-employment is considered stable and effective if the borrower has been self-employed for at least two years. Due to the high incidence of failure during the first few years of a new business, the following requirements must be met by individuals employed less than two years: |
| § | Less than one year . The income from borrowers who have been self-employed less than one year may not be considered as income. |
| § | Between one and two years . The income from borrowers who have been self-employed between one and two years may be counted if the individual has at least two years’ previous successful employment or a combination of one year of employment and one year of formal education or training in that or a related occupation. |
| § | Documentation Requirements. The following are required for self-employed borrowers: |
| § | Signed and dated individual tax returns, plus all applicable schedules, for the most recent two years. Verifiable financial statements are required if tax returns are not available. |
| § | Signed copies of federal business income tax returns for the past two years, with all applicable schedules, if the business is a corporation, an "S" corporation, or a partnership. |
| § | A year-to-date profit-and-loss statement and balance sheet (along with evidence of quarterly tax payments). |
| § | A business credit report for corporations and "S" corporations. |
| § | Nontraditional documentation of income is acceptable (e.g., fishing records). If non-taxable income, borrower must be able to show income receipts and expenses for a minimum two year period. |
