FHA Income Requirements-

Stable, predicable income and the likelihood of its continuance must be established to determine the FHA mortgage applicant’s capacity to repay FHA mortgage debt.  Income may not be used in calculating the borrower's income ratios if it comes from any source that cannot be verified, is not stable, and will not continue. 

Here are the acceptable types of FHA qualifying income, the procedures for calculating effective income, and the requirements for establishing income stability.

To analyze and document the probability of continued employment, FHA mortgage lenders must examine the loan applicant’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 or benefits, should be considered favorably.  In this analysis, FHA mortgage lenders will give greater weight to income stability than job stability.

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 following conditions apply:

          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.  Acceptable documentation includes traditional employment verifications, copies of W-2's, or copies of paystubs.

An example of an acceptable employment situation includes a person who took several years off work to raise children and then returned to the workforce.  Situations not meeting the criteria listed above may be considered as compensating factors only.

In most cases, the borrower’s income will be limited to salaries or wages.  Income from other sources can be included as effective income with proper verification by the lender.  Procedures for analyzing other acceptable income sources besides salaries and wages are described below:

 Overtime and Bonus Income- Both overtime and bonus income may be used to qualify if the borrower has received such income for the past two years and it is likely to continue.  The lender must develop an average of bonus or overtime income for the past two years, and the employment verification must not state that such income is unlikely to continue.  Periods of less than two years may be acceptable provided the lender justifies and documents in writing the reasons for using the income for qualifying purposes.

An earnings trend also must be established and documented for overtime and bonus income.  If either type shows a continual decline, the lender must provide a sound rationalization in writing for including the income for borrower qualifying.  If bonus income varies significantly from year to year, the lender must use a period of more than two years to calculating the FHA borrower’s average income.

Part-Time Income- Part-time/second job income, including employment in seasonal work, may be used in qualifying if the lender documents that the borrower has worked the part-time job uninterrupted for the past two years and will continue to do so.  Seasonal employment (for example, umpiring baseball games in summer, working at a department store during the holiday shopping season) is considered uninterrupted and may be used in qualifying if the lender documents that the borrower has worked the same type of job for the past two years and expects to be rehired during the next season. 

Income from a part-time position that has been received for less than two years may be included as effective income, provided the lender justifies and documents that the income's continuance is likely.  Income from part-time positions not meeting these requirements may be considered as a compensating factor only.

For qualification purposes, part-time income refers to income from jobs taken to supplement the borrower's income from regular employment (that is, a second job – not meaning primary jobs of less than 40 hours per week.)  If a borrower's regular employment involves less than a typical 40-hour workweek, the stability of that income should be evaluated in the same manner as any other regular, on-going primary employment.  For example, a registered nurse may have worked 24 hours per week for the last year.  Although this job requires less than 40 hours of work per week, it is the borrower's primary employment and is to be considered effective income.

We recognize that many low- and moderate-income families rely on part-time and seasonal income to meet their day-to-day needs.  Lenders must not restrict the consideration of such income sources in qualifying these borrowers.

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 is acceptable, provided its probability of continuance is verified in writing.  An additional consideration may be the tax-exempt nature of some of these payments.

Commission Income- Commission income must be averaged over the previous two years.  The borrower must provide copies of signed tax returns for the last two years, along with the most recent pay stub.  (Unreimbursed business expenses must be subtracted from gross income.) Individuals whose commission income shows a decrease from one year to the next require significant compensating factors to allow for loan approval.  Borrowers with commission income received for more than one but less than two years may be considered favorably provided the underwriter is able to make a sound rationalization for acceptance and can document the likelihood of continuance.

Commissions earned for less than one year are not considered effective income.  Exceptions may be made for situations in which the borrower's compensation was changed from a salary to commission within a similar position with the same employer.  A borrower also may qualify if the portion of earnings not attributed to commissions would be sufficient to qualify the borrower for the mortgage.

Retirement and Social Security Income- Retirement and social security income require verification from the source (former employer, Social Security Administration) or federal tax returns.  If any benefits expire within the first full three years, the income source may be considered only as a compensating factor.

Alimony, Child Support, or Maintenance Income- Income in this category may be considered as effective 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 final divorce decree, legal separation agreement, or voluntary payment agreement, as well as evidence that payments have been received during the last twelve months.  Acceptable evidence of payment regularity includes cancelled checks, deposit slips, tax returns, and court records.  Periods less than twelve months may be acceptable, provided the payer’s ability and willingness to make timely payments is adequately documented by the lender.

Notes Receivable- A copy of the note must be presented to establish the amount and length of payment.  The borrower also must provide evidence that these payments have been received consistently for the last twelve months, which may include deposit slips, cancelled checks, or tax returns.  If the borrower is not the original payee on the note, the lender must also establish that the borrower is now a holder in due course and able to enforce the note.

Interest and Dividends- Interest and dividend income may be used, provided that 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.

Mortgage Credit Certificates- If a government entity subsidizes the mortgage payments, either through direct payments or through tax rebates, these payments can be considered as acceptable income if verified in writing.  Either type of subsidy may be added to gross income or may be used to directly offset the mortgage payment before calculating the qualifying ratios.

Employer Differential Payments- If the employer subsidizes the mortgage payments through direct payments, the amount of the payments from the employer is considered gross income; it may not be used to offset the mortgage payment directly, even if the employer pays the servicing lender directly.

VA Benefits- Direct compensation, such as for a service-related disability, is acceptable, subject to documentation from the VA.  Education benefits, used to offset education expenses, are not acceptable.

Government Assistance Programs- Income received from government assistance programs is acceptable, subject to documentation from the paying agency, provided the income is expected to continue at least three years.  If the income is not expected to be received for at least three years, such income may be considered as a compensating factor.  (Unemployment income must be documented for two years.  Reasonable assurance of its continuance is also required.  This requirement may apply to individuals employed on a seasonal basis, such as farm workers, resort employees, etc.)

Rental Income- Rent received for properties owned by the borrower is acceptable if the lender can document that the rental income is stable.  Examples of stability may include a current lease, an agreement to lease, or a rental history over the previous 24 months that is free of unexplained gaps greater than three months.  (Student, seasonal, or military renters, or property rehabilitation would provide such an explanation).  A separate schedule of real estate is not required for rental properties, provided all properties are shown on the URLA.

If the borrower resides in one or more units of a multiple-unit property and charges rent to tenants of other units, that rent may be used for qualifying purposes.  However, projected rent of additional units only and not the owner-occupied unit(s) may be considered gross income only after deducting the HOC’s vacancy and maintenance factor.  They may not be used as a direct offset to the mortgage payments. 

Income from roommates in a single-family property to be occupied as the borrower's primary residence is not acceptable.  Rental income from boarders is acceptable if the boarders are related by blood, marriage, or law.  The rental income may be considered effective income if shown on the borrower's tax returns.  Otherwise, the income only may be considered a compensating factor and must be documented adequately by the lender.

The following is required to verify all rental income:

1.       Schedule E of IRS Form 1040.  Depreciation may be added back to the net income or loss shown on Schedule E.  Positive rental income is considered gross income for qualifying purposes; negative rental income must be treated as a recurring liability.  The lender must be certain that the borrower still owns each property listed, by comparing the Schedule E with the real estate owned section of the residential loan application.  (If the borrower in the same general area owns six or more units, a map disclosing the locations must be submitted evidencing compliance with FHA's seven-unit limitation.  See paragraph 4-8 for additional information.)

2.       Current Leases.  If a property was acquired since the last income tax filing and is not shown on 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 25 percent (or the percentage developed by the jurisdictional HOC), before subtracting PITI and any homeowners' association dues, etc., and applying the remainder to income (or recurring debts, if negative).

3.       Eligible Investment Properties.  If the property to be insured is an eligible investment property or sold through FHA's REO program, the following calculations of qualifying ratios apply:

          Subtract the monthly payment (PITI) from the monthly net rental income of the subject property (gross rents, minus the 25 percent reduction or HOC’s percentage reduction for vacancies and repairs).  If this calculation yields a positive number, add the number to the borrower's monthly gross income.  If the calculation results in a negative number, consider it a recurring monthly obligation; then

          Calculate the mortgage payment-to-income ratio (top or front-end ratio) by dividing the borrower's current housing expense (principal residence) by the monthly gross income.  (The monthly gross income will include any positive cash flow from the subject investment property.); and

          Calculate the total fixed payment-to-income ratio (bottom or back-end ratio) by dividing the borrower's total monthly obligations, including any net loss from the subject investment property, by the borrower's total monthly gross income.

Automobile Allowances and Expense Account Payments- Only the amount by which the borrower's automobile allowance or expense account payments exceed actual expenditures may be considered income.  The borrower must provide IRS Form 2106, Employee Business Expenses, for the previous two years to establish the amount of income that may be added to gross income.  The borrower also must provide verification from the employer that these payments will continue.  (If these calculations show a loss, that amount must be treated as a recurring debt.  If the borrower uses the standard per-mile rate in calculating automobile expenses, as opposed to the actual cost method, the portion that the IRS considers depreciation may be added back to income.)  Additionally, the borrower's monthly car payment must be treated as a recurring debt; it may not be offset by the car allowance.

Trust Income- Income from trusts may be used if guaranteed, constant payments will continue for at least the first three years of the mortgage term. Documentation is required and includes a copy of the Trust Agreement, or other trustee's statement, confirming amount, frequency of distribution, and duration of payments.  Funds from the trust account also may be used for the required cash investment with adequate documentation.

Non-Taxable Income- If a particular source of regular income is not subject to federal taxes (e.g., certain types of disability and public assistance payments, military allowances), the amount of continuing tax savings attributable to the non-taxable 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 (the amount the income is "grossed up") made for any non-taxable income source.  Child support income cannot be grossed up.  The lender should use the tax rate used to calculate last year's income tax for the borrower.  If the borrower is not required to file a federal income tax return, the tax rate to use is 25 percent. 

Projected Income- Projected or hypothetical income is not acceptable for qualifying purposes.  However, exceptions are permitted to this rule for income from cost-of-living adjustments, performance raises, bonuses, etc., which are both verified by the employer in writing and scheduled to begin within 60 days of loan closing.