In analyzing a self-employed borrower’s personal income, the lender should focus on earnings trends and the actual sources of the income, not just on the total amount of the income. The lender must confirm the stability and likelihood of continuance for each source of income that the borrower reports on his or her IRS Form 1040. The lender should not include any income that does not appear to be stable or likely to continue. The lender should, however, consider all recurring income that the borrower can expect to continue receiving over time.
Income may be considered as recurring if the loan application package does not include any specific indication of an upcoming change in the borrower’s employment or income, the borrower’s employment history has no gaps or other significant fluctuations in income, and any income received under a contractual agreement (other than an “at will” contract) will continue to be received for at least three years.
Examples of recurring income include:
regular salaries or wages,
bonus or commission income that has been received on a consistent basis,
interest income from long-term investments that are not being liquidated in connection with the mortgage transaction, and
earnings from the operation of the borrower’s business.
Any nonrecurring loss (such as an extraordinary one-time expense) should not be included in the cash flow analysis; therefore, in developing the borrower’s qualifying income, the lender should adjust the borrower’s cash flow by the amount of any nonrecurring loss.
IRS Form 1040 permits a taxpayer to adjust his or her total reported income by reporting certain deductions in the “Adjusted Gross Income” section.
If a lender uses the adjusted gross income approach to its cash flow analysis, it should add back to the borrower’s cash flow all deductions in this section that represent:
voluntary payments to savings accounts (IRA and Keogh deductions),
deductions for taxes or health insurance plans,
deductions for obligations that must be counted in the calculation of the borrower’s debt-to-income ratio (such as alimony or payments on student loans), and
other nonrecurring expenses (such as moving expenses or penalties for early withdrawal of savings).
The table below provides references to the Announcements that have been issued that are related to this topic.
|Announcement SEL-2015–09||August 25, 2015|