Are you thinking about using an FHA loan to buy a house? If so, there’s an important phrase you should know about. It’s called the “Effective Income.” Mortgage lenders will calculate this number when considering you for a loan. Here are the latest income requirements for FHA borrowers.
FHA Income Requirements Outlined in HUD Handbook
Note: The FHA income requirements outlined below were adapted from HUD Handbook 4000.1, the Single Family Housing Policy Handbook, which took effect in September 2015. These guidelines apply to loans that are underwritten using the TOTAL automated underwriting system. There are additional guidelines for manual underwriting, and those can be found in the aforementioned handbook.
Definition of Effective Income (TOTAL)
Within the context of FHA loans, “effective income” is any income that can be used to qualify a borrower for a home loan. Department of Housing and Urban Development (HUD) guidelines state that the borrower’s effective income should be “reasonably likely to continue through at least the first three years of the mortgage.” Additionally, an FHA borrower’s income must meet the specific requirements stated below.
i. General Income Requirements
The mortgagee (i.e., the mortgage lender that is generating the FHA loan) is required to document the borrower’s income and employment history for qualification purposes. Mortgagees must also verify the accuracy of the income amount reported by the borrower, and determine that it meets all other requirements listed below.
According to HUD / FHA guidelines, mortgage lenders can only consider income that is legally derived and, when required, properly reported as income on the applicant’s tax returns.
If a borrower has negative income, the mortgagee should subtract if from the gross monthly amount. Negative income should not be treated as a recurring monthly liability unless otherwise noted.
ii. Employment Related Income
HUD Handbook 4000.1 defines employment income as any income “received as an employee of a business that is reported on IRS Form W-2.” Lenders can use this as effective income for the purposes of qualifying a mortgage applicant, in accordance with the standards and requirements provided for each type of employment-related income.
When reviewing and considering a borrower’s employment-related income, the mortgagee (lender) must “verify the borrower’s most recent two years of employment and income,” and document this verification process using one of the following methods.
(1) Traditional Current Employment Documentation
When verifying current employment, mortgage lenders should obtain the most recent pay stub from the borrower, along with one of the following:
- a written Verification of Employment (VOE) covering two years; or
- an electronic verification acceptable to FHA.
Re-verification of the borrower’s employment should be finished within 10 days prior to the date of the note, according to current HUD guidelines for FHA income verification. The handbook states that “Verbal re-verification of employment is acceptable.”
(2) Alternative Current Employment Documentation
If a mortgage lender is using alternative documentation to verify a borrower’s income for FHA purposes, the lender must:
- obtain copies of the most recent pay stub with year-to-date earnings;
- obtain copies of the original W-2 forms from the previous two years; and
- document current employment by telephone, sign and date the verification documentation, and note the name, title, and telephone number of the person with whom employment was verified.
A 10-day rule is used for re-verification of employment. Re-verification must be completed within 10 days prior to the date of the note. It can be done verbally, according to the FHA income requirements outlined in HUD Handbook 4000.1.
(3) Past Employment Documentation
Direct verification of an FHA borrower’s employment history including the previous two years is not required if all of the conditions below have been met:
- The borrower’s current employer confirms an employment history of two years, or a paystub reflects a hiring date.
- Only base pay income is used to qualify the borrower (with no overtime or bonus-related income).
- The Borrower executes IRS Form 4506, Request for Copy of Tax Return, IRS Form 4506-T, Request for Transcript of Tax Return, or IRS Form 8821, Tax Information Authorization, for the previous two tax years.
If the FHA mortgage applicant has not been employed with the same employer for the previous two years and/or not all conditions immediately above can be met, the Mortgagee (mortgage lender) must verify the applicant’s employment history using one or a combination of the following items:
- Verification of Employment (VOE) form(s)
- IRS W-2(s)
- electronic verification acceptable to FHA
- evidence supporting enrollment in school or the military during the most recent two full years
Salary versus Hourly Income
When calculating effective income, the following standards apply to salary vs. hourly employees:
Salary: For employees who receive a salary (and whose income has been and will likely remain consistently earned), Mortgagees should use the applicant’s current salary to determine Effective Income.
Hourly: If an employee is paid hourly and has hours that do not vary, Mortgagees must consider the applicant’s current hourly rate when calculating Effective Income. If an hourly employee has hours that vary, the lender should average the income over the previous two years. Lastly, according to FHA income requirements: “If the Mortgagee can document an increase in pay rate the Mortgagee may use the most recent 12-month average of hours at the current pay rate.”
Important disclaimers: This article provides a quick overview of the latest FHA income requirements and explains how mortgage lenders should calculate a borrower’s Effective Income. The information above was adapted from HUD Handbook 4000.1. We’ve made every effort to ensure the accuracy of this content. With that being said, this website is not an official source for FHA policy or guidelines. For the current and most accurate information regarding FHA income requirements, please refer to the HUD.gov website. You can also contact the FHA Resource Center directly by calling 800-CALL-FHA (225-5342), or by sending an email to email@example.com.