Chapter 12: Income Analysis


Overview

Income analysis is one of the most critical aspects of the mortgage underwriting process. The goal is to determine whether a borrower has stable and sufficient income to support the proposed mortgage payment and other obligations. This chapter outlines the various income types, methods of calculation, required documentation, and key underwriting guidelines used to assess income.

Section 1: Types of Income

1.1 Employment Income

  • Salaried (W-2) Employees: Fixed monthly or annual salary
  • Hourly Employees: Income varies based on hours worked
  • Overtime, Bonus, and Commission: Must be consistent and likely to continue

1.2 Self-Employment Income

  • Sole proprietorship, partnerships, S-corporations, or corporations
  • Income evaluated based on tax returns (1040, Schedule C, E, F, K-1, 1120S, etc.)

1.3 Other Income Types

  • Rental income
  • Alimony or child support
  • Retirement/pension income
  • Disability/Social Security income
  • Investment and interest income
  • Trust income

Section 2: Documentation Requirements

2.1 Salaried and Hourly Employees

  • Recent 2 years W-2 forms
  • Most recent 30-day paystubs
  • VOE (Verification of Employment), if needed

2.2 Self-Employed Borrowers

  • Personal and business federal tax returns (last 2 years)
  • Year-to-date P&L (Profit & Loss) statement
  • Balance sheet for current year
  • Business license or CPA letter

2.3 Other Sources

  • Divorce decree or child support court order
  • Award letters (SSA, VA)
  • Pension/annuity statements
  • Lease agreements (rental income)
  • Bank statements for recurring deposits

Section 3: Analyzing Stability and Continuance

3.1 Income Stability

  • Minimum 2-year history required
  • Must be expected to continue for at least 3 years (especially for bonus/commission, child support, etc.)

3.2 Red Flags

  • Recent job changes or gaps in employment
  • Fluctuating income trends (downward)
  • Unverifiable income sources

Section 4: Income Calculation Methods

4.1 Salaried Income

  • Annual salary ÷ 12 = Monthly income

4.2 Hourly Income

  • Regular hours × hourly rate = monthly income
  • If hours vary: average hours over prior 12 or 24 months

Example:
40 hrs/week × $20/hr × 52 weeks ÷ 12 = $3,466.67 monthly

4.3 Overtime/Bonus/Commission

  • Use 24-month average (if consistent and likely to continue)
  • Exclude if not received consistently

4.4 Self-Employment

  • Adjusted gross income from tax returns
  • Add back non-cash expenses (e.g., depreciation)
  • Subtract one-time or non-recurring income

Example:
Net income (Schedule C) + depreciation – business use of home = qualifying income

Section 5: Rental Income Analysis

5.1 Documentation

  • Lease agreement (current and signed)
  • Schedule E from tax return (for history)
  • Proof of current rent deposits (bank statements)

5.2 Calculation (Conventional)

  • Gross Rent – 25% vacancy – PITI = Net rental income

Example:
$1,000 rent – $250 (25%) – $600 PITI = $150 net income

Section 6: Non-Taxable Income

6.1 Types

  • Social Security (some cases)
  • VA benefits
  • Disability income
  • Child support (some cases)

6.2 Gross-Up Calculation

  • Gross-up by 15–25% (depending on guidelines)

Example:
$1,000 tax-free × 1.25 = $1,250 qualifying income

Section 7: Special Income Scenarios

7.1 Part-Time Income

  • 2-year history required
  • Must be likely to continue

7.2 Seasonal Income

  • Must show history and likelihood of recurrence (e.g., landscaping, agriculture)

7.3 Newly Employed Borrowers

  • Offer letter or employment contract
  • First paystub required before closing

7.4 Asset Depletion

  • Used for high-net-worth borrowers
  • Divide liquid assets by fixed term (e.g., 360 months)

Section 8: AUS and Manual Underwriting

8.1 AUS (DU/LP) Requirements

  • System will auto-calculate if income is entered correctly
  • Flags inconsistent income history

8.2 Manual Underwriting

  • Requires deeper analysis and more documentation
  • Income must meet investor and program guidelines

Section 9: Common Issues and Red Flags

9.1 Large Income Variations

  • Year-over-year drop may disqualify bonus/commission

9.2 Incomplete Tax Returns

  • Missing schedules or pages may delay approval

9.3 Unverifiable Income

  • Must be documented through reliable third-party sources

9.4 Undisclosed Business Losses

  • Self-employed borrowers may report personal income, but business losses on Schedule C/E

Section 10: Case Studies

Case 1: Hourly Worker with Overtime

  • Borrower works 40 regular hours + 10 OT
  • 24-month average OT used after verification
  • Stable pattern justified income usage

Case 2: Self-Employed for 1 Year

  • Only 1 year tax return — generally not acceptable
  • Loan declined or additional compensating factors required

Case 3: Alimony Income

  • Divorce decree reviewed
  • Income stable, received 12+ months, and will continue 36+ months
  • Included in DTI calculation

Final Notes

  • Consistency, stability, and documentation are key to qualifying income
  • When in doubt, always refer to agency/investor guidelines (Fannie Mae, Freddie Mac, FHA, etc.)
  • Clear documentation and analysis ensure compliant income assessment

 

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