Module 3: Income Documents

Income documents are an essential component of the mortgage application process. These documents provide proof of the borrower's income and help lenders assess their ability to repay the mortgage loan.

Income Calculation

In a mortgage application, the general income calculation is used to assess the borrower's ability to repay the loan. Lenders evaluate various income sources and apply specific guidelines to determine the qualifying income. Here are some key aspects of the general income calculation in a mortgage application:

Employment Income:

For borrowers who are employed, lenders typically consider the income documented through pay stubs, W-2 forms, and employment verification. The lender will calculate the borrower's gross monthly income based on the regular salary or hourly rate, taking into account any eligible overtime, bonuses, or commissions. Lenders may also require a history of consistent employment, typically spanning two years.

Self-Employment Income:

Self-employed borrowers have more complex income calculations. Lenders typically review the borrower's tax returns, including Schedule C (Profit or Loss from Business) and/or other relevant forms, to determine the net income. The lender may consider an average of the borrower's income over the past two years or apply other adjustments based on the business's stability and profitability.

Other Income Sources:

Lenders also consider additional income sources, which can include but are not limited to:

• Rental Income: If the borrower owns rental properties, lenders may consider a portion of the rental income after subtracting applicable expenses and vacancy factors. Supporting documentation such as lease agreements and tax returns may be required.

• Retirement Income: Lenders may consider income from retirement accounts, such as pensions, 401(k)s, IRAs, and Social Security benefits. Documentation like award letters or benefit statements may be required.

• Investment Income: Income derived from investments, such as dividends, interest, capital gains, or distributions from mutual funds, may be factored into the income calculation. Lenders may request supporting documentation, such as investment account statements or tax returns.

• Alimony or Child Support: If the borrower receives alimony or child support, lenders may consider it as qualifying income, subject to certain criteria. The borrower must provide evidence of a consistent receipt of these payments, typically through divorce decrees, court orders, or bank statements.

Debt-to-Income Ratio (DTI):

The income calculation is used in conjunction with the borrower's debts to determine their DTI ratio, which is a crucial factor in the mortgage underwriting process. DTI compares the borrower's total monthly debt obligations, including the mortgage payment, to their gross monthly income. Lenders have specific DTI requirements, and a lower DTI ratio generally indicates a stronger financial position and a higher likelihood of loan approval.

Documentation Requirements: Lenders require borrowers to provide accurate and complete documentation to support their income claims. This can include pay stubs, W-2 forms, tax returns, bank statements, rental agreements, retirement account statements, and other relevant documents. The lender will review these documents to validate the income and assess its stability.

It's important to note that each lender may have slightly different criteria and guidelines for income calculations. Additionally, specific loan programs, such as FHA, VA, or conventional loans, may have varying requirements.

In summary, the general income calculation in a mortgage application involves assessing various income sources, such as employment income, self-employment income, rental income, retirement income, and other income streams. Lenders use specific guidelines and documentation to calculate the qualifying income and determine the borrower's ability to repay the mortgage loan. The income calculation is an important factor in determining the borrower's debt-to-income ratio and overall loan eligibility.

Income Worksheet

The income worksheet, also known as the income analysis or income calculation worksheet, is a tool used by lenders to document and analyze the borrower's income sources and determine their qualifying income for a mortgage loan. The worksheet provides a structured format to gather information and perform calculations related to the borrower's income. Here are some key aspects of the income worksheet:

• Income Source Details: The income worksheet typically begins by collecting detailed information about each income source. This includes the nature of the income (e.g., employment, self-employment, rental income), the name and address of the employer or business, and the duration of the income (e.g., full-time, part-time, seasonal).

• Income Calculation Method: The worksheet outlines the specific calculation method for each income source. It provides guidance on how to calculate the qualifying income based on the type of income and any applicable guidelines or requirements from the lender or loan program. The calculation method may include formulas, percentages, or specific adjustments depending on the income source.

• Gross Income Calculation: The income worksheet helps determine the borrower's gross income, which is the total income earned before deductions or taxes. It includes base salary, hourly wages, tips, commissions, bonuses, and any other regular income components. The worksheet may provide guidelines on how to calculate the gross income for different income sources, such as annualizing hourly wages or factoring in overtime pay.

• Deductions and Adjustments: In addition to gross income, the income worksheet may account for certain deductions or adjustments that impact the qualifying income. These deductions can include pre-tax contributions to retirement accounts, health insurance premiums, or other eligible expenses. The worksheet provides instructions on how to calculate these deductions accurately.

• Net Income Calculation: The net income represents the amount of income remaining after deductions and adjustments. The worksheet guides the calculation of net income for each income source, considering applicable taxes, expenses, and other factors specific to the borrower's situation. For self-employed borrowers, the net income calculation may involve analyzing business expenses and deductions related to the self-employment income.

• Summary and Total Qualifying Income: Once the calculations for each income source are completed, the worksheet provides a summary section where the qualifying income from all sources is totaled. This final figure represents the borrower's income that will be considered by the lender for mortgage qualification purposes.

It's important to note that the specific format and details of the income worksheet can vary among lenders or loan programs. Some lenders may use standardized worksheets, while others may have their own customized versions.

LoanBeam

LoanBeam is a technology platform that specializes in automated income calculation and verification for mortgage lending. It is designed to streamline and simplify the income verification process by leveraging advanced optical character recognition (OCR) and artificial intelligence (AI) technologies. LoanBeam's primary focus is on analyzing and extracting income data from tax documents, such as tax returns and W-2 forms, to determine the borrower's qualifying income.

Here are some key features and benefits of LoanBeam:

• Automated Income Calculation: LoanBeam uses OCR technology to scan and extract relevant income data from tax documents. This eliminates the need for manual data entry and significantly reduces the time and effort required to calculate a borrower's income.

• Tax Return Analysis: LoanBeam can accurately analyze various types of tax returns, including individual tax returns (such as IRS Form 1040) and business tax returns (such as IRS Form 1120). It examines the income, deductions, and other relevant sections of the tax return to determine the borrower's qualifying income.

• Enhanced Accuracy: By leveraging AI algorithms, LoanBeam helps minimize errors and improves the accuracy of income calculations. It can handle complex scenarios, such as self-employment income, rental income, and other non-standard income sources, ensuring precise and consistent calculations.

• Compliance and Risk Management: LoanBeam helps lenders adhere to regulatory requirements and mitigate risk. The platform applies consistent income calculation methods, ensuring compliance with lending guidelines and reducing the chances of errors or discrepancies.

• Integration Capabilities: LoanBeam integrates with various loan origination systems (LOS) and other mortgage technology platforms, allowing seamless data transfer and workflow integration. This enables lenders to incorporate LoanBeam's income calculation capabilities into their existing processes without disrupting their workflow.

It's important to note that LoanBeam is a specialized tool for income verification and calculation, primarily focusing on tax documents. While it can significantly streamline the income analysis process, lenders may still require additional documentation and manually review other aspects of a borrower's financial profile during the mortgage underwriting process.

W-2 Employee Income Documents

W-2 employee income documents play a crucial role in verifying and documenting the income of borrowers who are employed by a company or organization. A W-2 form, also known as the Wage and Tax Statement, is provided by the employer to each employee and reports the employee's annual wages and tax withholdings. Here are some important details about W-2 employee income documents:

• Contents of a W-2 Form: A standard W-2 form consists of several sections, including:

  • Employee Information: This section includes the employee's name, address, and Social Security number, as well as the employer's identification information.

  • Wage and Salary Information: This section displays the employee's total wages, tips, and other compensation received during the tax year. It outlines the breakdown of different types of income, such as regular wages, bonuses, commissions, and any taxable fringe benefits.

  • Tax Withholdings: The W-2 form provides information on federal, state, and local income tax withholdings from the employee's wages throughout the year. It also includes details of other deductions, such as Social Security and Medicare taxes.

  • Additional Information: The W-2 form may include other relevant information, such as retirement plan contributions, employer-sponsored healthcare coverage, and other benefits provided to the employee.

• Income Verification: Lenders use W-2 forms to verify and validate the borrower's income for previous years.

• Income Calculation: Lenders typically consider the income reported on the W-2 form as the basis for calculating the borrower's qualifying income. They may review the W-2 forms from the past two years to assess the borrower's income history and stability. However, if there are significant changes in income or employment, lenders may require additional documentation or explanations.

• Additional Documentation: In some cases, lenders may request additional documents in conjunction with W-2 forms to provide a more comprehensive view of the borrower's income. This can include pay stubs, employment verification letters, or other supporting documents to verify employment status and income consistency.

• W-2 & Self-Employment Income: It's important to note that if a borrower has both W-2 income and self-employment income, lenders will generally treat these income sources separately. The W-2 income will be assessed based on the corresponding W-2 forms, while self-employment income will be evaluated using additional documentation, such as tax returns and profit and loss statements.

Self-Employed Income Documents

When it comes to self-employed individuals, documenting their income for a mortgage application can be more complex compared to W-2 employees. Lenders typically require self-employed borrowers to provide additional documentation to verify their income and assess their ability to repay the loan. Here are some common self-employed income documents:

• Profit and Loss (P&L) Statement: A P&L statement, also known as an income statement or statement of operations, provides an overview of the self-employed individual's revenue, expenses, and net income for a specific period. It helps lenders understand the profitability of the business and assess the borrower's income stability. The P&L statement should be prepared by a certified public accountant (CPA) or a qualified financial professional.

• Business Tax Returns: Lenders often require self-employed borrowers to provide complete copies of their business tax returns, such as IRS Form 1040 Schedule C (Profit or Loss from Business). These returns show the income, deductions, and net profit or loss of the business. Lenders typically review two years' worth of tax returns to assess income consistency and identify any significant changes in income.

• 1099 Forms: If the self-employed individual receives income from clients or customers in the form of 1099-MISC or 1099-NEC, these forms should be included as supporting documentation. They provide additional evidence of the income earned from specific sources.

• Bank Statements: Lenders may request personal and business bank statements to verify cash flow, deposits, and business expenses. These statements help confirm the self-employed borrower's income and provide insight into the financial health of the business. Lenders typically review several months' worth of bank statements to assess income patterns and stability.

• Business License or Registration: Providing proof of the self-employed individual's business license or registration can help validate the legitimacy and legal status of the business. It establishes that the borrower is operating a viable business and generating income from it.

• Client Contracts or Invoices: Self-employed borrowers may be asked to provide client contracts or invoices as further evidence of ongoing business activities and income generation. These documents demonstrate the existence of business relationships, payment terms, and the nature of services or products provided.

• CPA Letter: In some cases, lenders may require a letter from a certified public accountant (CPA) verifying the self-employed borrower's income. The CPA letter validates the accuracy of the financial information provided, confirms the self-employed status, and provides additional assurance to the lender.

It's important to note that each lender may have specific requirements regarding self-employed income documentation. Some lenders may have additional guidelines or request additional documents depending on the complexity of the borrower's business structure or income sources.

Written and Verbal VOE’s

Written and verbal VOE (Verification of Employment) are two methods used by lenders to confirm a borrower's employment status and income when processing a mortgage application. These verifications provide lenders with assurance that the borrower has a stable income source to support the mortgage repayment. Here's an overview of written and verbal VOEs:

Written VOE:

A written VOE is a formal document obtained directly from the borrower's employer or a designated third-party verifier. It typically includes the following information:

• Employee Details: The written VOE confirms the borrower's name, job title, and employment start date.

• Employment Status: It verifies whether the borrower is a full-time, part-time, or contract employee.

• Income Details: The written VOE specifies the borrower's base salary, hourly wage, or any other forms of regular income. It may also include information about additional compensation, such as bonuses, commissions, or overtime pay.

• Length of Employment: The written VOE provides details on the length of the borrower's employment with the company.

• Contact Information: The document usually includes the employer's contact information, such as name, address, and phone number, along with the verifier's contact details if applicable.

Lenders typically request written VOEs directly from the employer or through a third-party employment verification service. The employer or verifier completes the form and sends it directly to the lender to validate the borrower's employment details.

Verbal VOE:

A verbal VOE involves the lender contacting the borrower's employer directly via phone to obtain employment verification. During the call, the lender typically speaks with a designated representative, such as a human resources or payroll department representative. The conversation covers similar information as in a written VOE, including:

• Employee Details: The lender confirms the borrower's identity and employment status.

• Employment Verification: The lender verifies the borrower's position, start date, end date (if any).

• Length of Employment: The lender confirms the length of the borrower's employment with the company.

Verbal VOEs allow lenders to gather immediate information and clarify any questions or discrepancies regarding the borrower's employment. It is a more interactive process compared to written VOEs.

Other Income Sources: Rental, SSI, Disability

In addition to traditional employment income, there are several other income sources that borrowers may have, such as rental income, Social Security Income (SSI), and disability benefits. These alternative income sources can be considered by lenders when evaluating a borrower's ability to repay a mortgage loan. Here's an overview of these income sources:

Rental Income:

If a borrower owns rental property, the rental income generated can be included as part of their overall income calculation. Lenders typically require documentation to verify rental income, which may include:

• Lease Agreements: Providing copies of lease agreements helps establish the rental terms, duration, and rental income amount.

• Rental Payment History: Lenders may request bank statements or canceled rent checks to verify a consistent history of rental income deposits.

• Schedule E (IRS Form 1040): Borrowers who report rental income on their tax returns can provide a Schedule E, which details the income and expenses associated with the rental property.

Lenders may have specific guidelines on the treatment of rental income, including requirements for rental history duration and income stability. Deductions for property expenses, vacancy rates, and potential rental income losses may also be considered.

The vacancy rate or vacancy factor refers to the percentage of time that a rental property is expected to be unoccupied or vacant. Lenders consider this factor when assessing the income potential and risk associated with an investment property, particularly when determining the maximum loan amount for a borrower. Lenders incorporate the vacancy rate into their calculations to ensure that borrowers can still meet their mortgage obligations even during periods when the property may not be generating rental income.

For example, if a lender determines that a property's vacancy rate is 10%, it means that they expect the property to be vacant or unoccupied for approximately 10% of the time. This factor is then taken into account when assessing the property's rental income and determining the borrower's eligibility for a mortgage.

Social Security Income (SSI):

Social Security Income is a federal assistance program providing financial support to individuals who are disabled, blind, or elderly and have limited income and resources. When evaluating SSI as a source of income, lenders typically require documentation, such as:

• Benefit Verification Letter: Borrowers can obtain a benefit verification letter from the Social Security Administration (SSA) that confirms the amount of SSI received.

• Bank Statements: Providing bank statements that show the regular deposit of SSI funds can help verify the income.

Lenders will consider the stability and duration of the SSI income to assess its suitability for mortgage qualification. It's important to note that not all lenders accept SSI as a qualifying income source, so borrowers should discuss their specific situation with their lender or mortgage professional.

Disability Benefits:

Disability benefits may be provided by private insurance policies or government programs, such as Social Security Disability Insurance (SSDI). The documentation required for verifying disability benefits as income can include:

• Benefit Award Letter: Borrowers can provide an official benefit award letter from the disability benefits provider, detailing the amount and duration of the disability benefits.

• Bank Statements: Lenders may request bank statements that show regular deposits of disability benefit payments.

Similar to SSI, lenders will consider the stability and duration of disability benefits as part of the borrower's overall income assessment.

Tax Transcripts

Tax transcripts are official documents provided by the Internal Revenue Service (IRS) that summarize a taxpayer's filed tax information. Lenders often require tax transcripts as part of the mortgage application process to verify a borrower's income and confirm the accuracy of the tax returns submitted. Here's some key information about tax transcripts:

Types of Tax Transcripts:

The IRS offers different types of tax transcripts that lenders may request:

• Tax Return Transcript: This transcript provides a summary of the information from the original tax return, including line items and schedules.

• Tax Account Transcript: This transcript provides a record of any adjustments made to the taxpayer's account after the tax return was filed. It includes information about payments, penalties, interest, and changes made by the IRS.

• Wage and Income Transcript: This transcript provides information about the income reported to the IRS by employers, financial institutions, and other payers. It can be useful for verifying employment and other income sources reported on the tax return.

Requesting Tax Transcripts:

Borrowers can request tax transcripts directly from the IRS using various methods:

• Online Request: The IRS offers an online tool called "Get Transcript" that allows taxpayers to view and print their tax transcripts online.

• Phone Request: Taxpayers can call the IRS to request tax transcripts by phone. The transcripts are then mailed to the taxpayer's address on file.

• Mail Request: Borrowers can complete Form 4506-T (Request for Transcript of Tax Return) and mail it to the appropriate IRS address listed on the form. The requested transcripts will be sent by mail.

Purpose in Mortgage Lending:

Lenders typically request tax transcripts to verify the borrower's income and confirm the accuracy of the tax returns submitted with the mortgage application. By reviewing the tax transcripts, lenders can:

• Verify Income: Lenders compare the income reported on the tax return to the income information on the tax transcripts to ensure consistency and accuracy.

• Identify Discrepancies: Tax transcripts may reveal discrepancies or differences between the filed tax returns and the income reported to the IRS, helping to identify potential issues or misrepresentations.

• Assess Tax Liabilities: Lenders review tax transcripts to assess any outstanding tax liabilities, penalties, or adjustments that could impact the borrower's financial standing and ability to repay the mortgage.

It's important to note that tax transcripts may take some time to obtain from the IRS, and lenders typically require the most recent two years of transcripts.