Nuances of Declining Income

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Often, underwriters are faced with a borrower, especially a self-employed borrower, whose income has declined year over year.  I wanted to provide a quick review regarding declining income for self-employed borrower(s) specifically for FHA loans.

There are a few paths a loan can follow. When income is declining year over year, it affects how the borrower’s income is calculated as well as the recommendation from TOTAL.

A self-employed borrower that received an approved/eligible recommendation and their income declined greater than 20%, results in a manual downgrade and the underwriter must follow the Manual Underwriting guidelines, which are different than that of the Total Underwriting guidelines.

Approved / Eligible Recommendation

• Declining Income less than 20% year over year with Approved/Eligible recommendation requires the borrower to have stable or increasing income to be acceptable.
• • Income is calculated by using the lesser of:
    • Average income earned over the previous two years; or
    • Average income earned over the previous one year
• Declining Income greater than 20% year over year with Approved/Eligible recommendation requires the loan to be manually downgraded and must follow the Manual Underwriting guidelines noted below.

Refer Recommendation

• Declining Income less than 20% year over year with refer recommendation requires the borrower to have stable or increasing income to be acceptable.
• • Income is calculated by using the lesser of:
    • Average income earned over the previous two years; or
    • Average income earned over the previous one year
• Declining Income greater than 20% year over year with refer recommendation or if manually downgraded requires the determination that the business income is now stable.
• • Income is determined to be stable:
    • Document the reduction in income was the result of an extenuating circumstance
    • Demonstrate the income has been stable or increasing for a minimum of 12 months
    • Borrower needs to qualify with the reduced income

It is a little complicated, but an understanding of the rules helps clarify your lending decisions. I will be publishing more of these simple guidelines to help underwriters understand some of the more complicated situations.

DISCLAIMER: The information contained herein is strictly for informational purposes only, is general in nature, and is not intended, and should not be relied upon or construed, as underwriting opinion or advice regarding any specific loan scenario or factual circumstance.  This information is not a substitute for the exercise of the reader’s own judgment based on current regulations and applicable guidelines.

About the Author

Elliot Salzman

As Chief Credit/Compliance Officer, Elliot Salzman is responsible for enhancing and managing both the credit and compliance policy functions for LoanLogics LoanHD® platform to deliver a more comprehensive approach for ensuring loan quality. Additionally, Salzman oversees the organization's Credit and Compliance Policies and Procedures. With over 26 years of mortgage industry experience, he has held numerous executive and supervisory roles related to operations, credit and compliance policy. Elliot's areas of expertise include in-depth knowledge of the end-to-end loan origination process, process improvement, quality assurance, quality control, compliance, secondary, loss mitigation and servicing. A former Underwriting Standards Manager for Fannie Mae, he most recently served as Senior Director of Credit Operations for First Guaranty Mortgage Corporation. Salzman's previous roles include Senior Vice President, Director of Consumer Policy and Underwriting for BBVA Compass Bank and Vice President of Correspondent Lending for The Bank of Oklahoma. Prior to this, Elliot built a Wholesale Banking platform in 2002 that originated to his firm's own guidelines for sale into the secondary markets. In late 2006, Elliot sold the company to a small boutique Wall Street firm. Mr. Salzman attended State University of New York at Albany.