B3-3.1-01, General Income Information (05/01/2024)

Fannie Mae’s underwriting guidelines emphasize the continuity of a borrower’s stable income. The stable and reliable flow of income is a key consideration in mortgage loan underwriting. Individuals who change jobs frequently, but who are nevertheless able to earn consistent and predictable income, are also considered to have a reliable flow of income for qualifying purposes.

To demonstrate the likelihood that a consistent level of income will continue to be received for borrowers with less predictable sources of income, the lender must obtain information about prior earnings. Examples of less predictable income sources include commissions, bonuses, substantial amounts of overtime pay, or employment that is subject to time limits, such as contract employees or tradesmen.

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.

For loans with variable income validated by the DU validation service, the required history of receipt may differ from the requirements described above. DU will determine the history required to validate an income type.

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 31^st 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 31^st 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 (such as 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.

A key driver of successful homeownership is confidence that all income used in qualifying the borrower will continue to be received by the borrower for the foreseeable future. Unless the lender has knowledge to the contrary, if the income does not have a defined expiration date and the applicable history of receipt of the income is documented (per the specific income type), the lender may conclude that the income is stable, predictable, and likely to continue. The lender is not expected to request additional documentation from the borrower.

If the income source does have a defined expiration date or is dependent on the depletion of an asset account or other limited benefit, the lender must document the likelihood of continued receipt of the income for at least three years.

If the lender is notified that the borrower is transitioning to a lower pay structure, for example due to pending retirement or a new job, the lender must use the lower amount to qualify the borrower.

The following table contains examples of income types with and without defined expiration dates. This information is provided to assist lenders in determining whether additional income documentation may be necessary to support a three-year continuance. Lenders are responsible for making the final determination of whether the borrower’s specific income source has a defined expiration date. See  B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income for additional information related to the use and documentation of specific income sources.

Note that continuity of income for trust income must be based on the type of income received through the trust. For example, if the income from the trust is derived from rental income, then three-year continuance is not required. However, if the income is a fixed payment derived from a depleting asset, then three-year continuance must be determined.

Income sources that are not listed above will require lender judgment to determine if documentation of continuance must be obtained.

The lender must obtain copies of the borrower’s signed federal income tax returns filed with the IRS for the past one or two years (depending on the income type) for the following sources of income or employment. Refer to the applicable topics in Chapter B3-3, Income Assessment for additional information about specific tax return requirements.

Tax returns are required if the borrower

• is employed by family members (two years’ returns);

• is employed by interested parties to the property sale or purchase (two years’ returns);

• receives rental income from an investment property;

• receives income from temporary or periodic employment (or unemployment) or employment that is subject to time limits, such as a contract employee or a tradesman;

• receives income from capital gains, royalties, or other miscellaneous non-employment earnings reported on IRS Form 1099;

• receives income that cannot otherwise be verified by an independent and knowledgeable source (two years’ returns);

• uses foreign income to qualify;

• uses interest and dividend income to qualify;

• uses tip income reported on IRS Form 4137 that was not reported by the employer on the W-2 to qualify; or

• receives income from sole proprietorships, limited liability companies, partnerships, or corporations, or any other type of business structure in which the borrower has a 25% or greater ownership interest. Borrowers with a 25% or greater ownership interest are considered self-employed. The lender must document and underwrite the loan application using the requirements for self-employed borrowers, as described in Section B3–3.2, Self-Employment Income. Note that for DU loan casefiles, only the most recent year of tax returns may be required.

If a borrower’s income is validated by the DU validation service, lenders are not required to determine if the borrower is employed by a family member or interested party to the property sale or purchase. See B3-2-02, DU Validation ServiceB3-2-02, DU Validation Service.

See B3-3.1-06, Requirements and Uses of IRS IVES Request for Transcript of Tax Return Form 4506-CB3-3.1-06, Requirements and Uses of IRS IVES Request for Transcript of Tax Return Form 4506-C, for information about obtaining tax return transcripts.

The following table describes income verification requirements for borrowers who are non-U.S. citizens:

For information on U.S. citizens earning foreign income, refer to  B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income.

The lender should give special consideration to regular sources of income that may be nontaxable, such as child support payments, Social Security benefits, workers’ compensation benefits, certain types of public assistance payments, and food stamps.

The lender must verify that the particular source of income is nontaxable, unless the source of income meets one of the exceptions below. Documentation that can be used for this verification includes award letters, policy agreements, account statements, tax returns or any other documents that address the nontaxable status of the income.

If the income is verified to be nontaxable, and the income and its tax-exempt status are likely to continue, the lender should develop an “adjusted gross income” for the borrower by adding an amount equivalent to 25% of the nontaxable income to the borrower’s income.

If the actual amount of federal and state taxes that would generally be paid by a wage earner in a similar tax bracket is more than 25% of the borrower’s nontaxable income, the lender may use that amount to develop the adjusted gross income, which should be used in calculating the borrower’s qualifying ratio.

Exceptions: 

The lender is not required to provide documentation to support that the income is nontaxable for the following:

• Child support income: The full amount of documented qualifying child support is nontaxable.
• Section 8 Housing Choice Voucher Homeownership Program payments: The full amount of income from these payments is nontaxable.
• Social Security income: 15% of the income is nontaxable.

Example for Social Security income

Benefit amount: $1,500

Nontaxable amount: $1,500 x 15% = $225

Gross-up amount: $225 x 25% = $56 (rounded to the nearest dollar)

Qualifying income: $1,556 (does not require additional documentation)

Note: If the lender opts to gross-up more than 15% of Social Security income, documentation to support that the additional income is nontaxable must be included in the loan file.

For certain high LTV refinance loans, lenders are not required to follow the income documentation requirements described in this Chapter. Refer to Chapter B5-7: High Loan-to-Value Refinance Option for specific requirements.

Any income paid to or earned by the borrower in the form of virtual currency, such as cryptocurrencies, is not eligible to be used to qualify for the loan. For other income types see B3-3.1-09, Other Sources of IncomeB3-3.1-09, Other Sources of Income.