As you pull up the buyer’s income documents and plug their year-to-date income into your income worksheet, you realize the numbers aren’t matching up. Their average monthly wages year to date are $400 less than their current hourly wage, and worse yet, they have only been on the job for 10 months!
What do you do?
If you’re not sure how to handle this relatively common situation, keep reading!
Identify Variable Hourly Income
Fannie Mae calls it Variable Income, Freddie Mac calls it Fluctuating Hourly Earnings, FHA simply says it’s Primary Employment Less Than 40 Hour Work Week. I’m going to call it variable hourly going forward. Variable hourly income refers to income that is earned on an hourly basis and has a history of varying from paycheck to paycheck. This can include income from full time jobs, part-time jobs, overtime, and both primary and secondary employment. Because variable hourly income can be unpredictable, it’s VITAL that loan officers are able to quickly identify it, and have a consistent process to calculate qualifying income when a borrower has variable hourly income.
Pro Tip: There are situations where a buyer’s hourly income can vary from paycheck to paycheck, but NOT be considered variable! If a buyer has temporarily reduced income due to FMLA leave and is paid hourly, their income would not be considered variable hourly if you can
(a) document the leave per guidelines, and
(b) income documents support 40 hours per week worked outside of the documented leave period.
Calculate Variable Hourly Income
To calculate variable hourly income, you first need to decide if it’s even usable as qualifying income.
Fannie Mae requires at least 12 months of job history with a specific employer in order to use variable hourly income as qualifying income, but Freddie Mac actually states the required 12 month history can come from current and former employer.
FHA on the other hand is much more flexible. If they’ve received a pay increase in the last 12 months, you’ll be able to multiply their current hourly wage over the average hours per week for the last 12 months. If they don’t have 12 months job history, you can use their average hours per week worked since they started their job as long as the employer states on the VOE that those hours are likely to continue.
Pro Tip: Fannie and Freddie will not consider income to be variable hourly IF the employer is willing to put in writing that the employee is GUARENTEED a minimum amount of hours. For example, if a buyers hours have varied between 35 and 40 hours per week, but never worked less than 35, and the year to date average income supports 35 hours worked per week, if the employer writes the employee is GUARENTEED 35 hours per week the income is no longer variable hourly and you can use it as qualifying income without meeting the 12 month history of receipt requirement.
To calculate variable hourly income, GSE guidelines are below:
Freddie Mac
Consistent and increasing income trends
If the income is consistent or the trend is increasing, the Seller must average the most recent year(s) and YTD income over the applicable number of months documented. However, if the increase between the prior year(s) and YTD earnings exceeds 10%, additional analysis is required and additional documentation may be necessary to determine income stability in order to use the higher amount when calculating the qualifying income. The analysis and documentation must support the amount of income used to qualify the Borrower. Acceptable factors include, but are not limited to, promotion and income increasing consistently year over year.
Declining trend
The Seller must use the year-to-date income and must not include the previous higher level unless there is documentation of a one-time occurrence (e.g., injury) that prevented the Borrower from working or earning full income for a period of time and evidence that the Borrower is back to the income amount that was previously earned.
If the decline between the prior year(s) and/or YTD earnings exceeds 10%, the Seller must conduct further analysis and additional documentation may be necessary to determine whether the income is currently stable. This analysis must include the reason for the declining trend, and support that the current income has stabilized.
Fannie Mae
Variable Income
All income that is calculated by an averaging method must be reviewed to assess the borrower’s history of receipt, the frequency of payment, and the trending of the amount of income being received. Examples of income of this type include income from hourly workers with fluctuating hours, or income that includes commissions, bonuses, or overtime.
History of Receipt: Two or more years of receipt of a particular type of variable income is recommended; however, variable income that has been received for 12 to 24 months may be considered as acceptable income, as long as the borrower’s loan application demonstrates that there are positive factors that reasonably offset the shorter income history.
Frequency of Payment: The lender must determine the frequency of the payment (weekly, biweekly, monthly, quarterly, or annually) to arrive at an accurate calculation of the monthly income to be used in the trending analysis (see below). Examples:
• If a borrower is paid an annual bonus on March 31st of each year, the amount of the March bonus should be divided by 12 to obtain an accurate calculation of the current monthly bonus amount. Note that dividing the bonus received on March 31st by three months produces a much higher, inaccurate monthly average.
• If a borrower is paid overtime on a biweekly basis, the most recent paystub must be analyzed to determine that both the current overtime earnings for the period and the year-to-date overtime earnings are consistent and, if not, why. There are legitimate reasons why these amounts may be inconsistent yet still eligible for use as qualifying income. For example, borrowers may have overtime income that is cyclical (transportation employees who operate snow plows in winter, package delivery service workers who work longer hours through the holidays). The lender must investigate the difference between current period overtime and year-to-date earnings and document the analysis before using the income amount in the trending analysis.
Income Trending: After the monthly year-to-date income amount is calculated, it must be compared to prior years’ earnings using the borrower’s W-2’s or signed federal income tax returns (or a standard Verification of Employment completed by the employer or third-party employment verification vendor).
• If the trend in the amount of income is stable or increasing, the income amount should be averaged.
• If the trend was declining, but has since stabilized and there is no reason to believe that the borrower will not continue to be employed at the current level, the current, lower amount of variable income must be used.
• If the trend is declining, the income may not be stable. Additional analysis must be conducted to determine if any variable income should be used, but in no instance may it be averaged over the period when the declination occurred.
FHA
For employees who are paid hourly and whose hours vary, the Mortgagee must use the average of the income over the previous two years. If the Mortgagee can document an increase in pay rate the Mortgagee may use the most recent 12-month average of hours at the current pay rate.
Pro Tip: If your borrowers have fewer than 12 months on a new job and are paid hourly with variable hours, it will be underwriter discretion if they will allow the hourly wage to be multiplied by the average hours worked per week since the start of the job, OR if they will take the hourly wage multiplied by the average hours worked per week for the last 12 months. I have had underwriters accept both calculations as long as we submit a solid rationale and documentation to support the rationale.
To sum it up...
Being able to accurately calculate qualifying income from variable hourly sources is a skill that is invaluable in the mortgage lending industry. If you do it wrong, it can easily mean the different between smiles at closing, and losing a referral partner. Knowing the property documents to ask for from the buyer is so important. I rarely ask for W2’s when I’m doing a preapproval, I’ll simply ask for most recent paystub, and the paystub for their last paycheck of the two prior calendar years. I like to see the breakdown of base wage, hours worked, overtime, bonus etc, because it allows me to calculate income the exact same way the underwriter will after they receive a written VOE.
Please let me know if you find any mistakes
Ben