Conventional Loan Guidance on Assets for Income - Part 2

Using assets for income can be extremely useful when qualifying a borrower. However, if the calculations used are incorrect, the amount of qualifying income could vary significantly, leading to a borrower crossing over the DTI threshold for qualification. Let's make sure to look at what both FNMA and FHLMC say about calculating this type of income - and it is not the same!

Up first we will look at how FHLMC calculates income under the guidance of "assets as a basis of repayment of obligations." For those that enjoy simplicity, this is just about as simple as it gets. First, calculate the total amount of assets being used. This is done by taking the gross assets and subtracting out: 1) any funds required to be paid by the borrower to complete the subject transaction, 2) any gift funds and borrowed funds, and 3) any portion of assets pledged as collateral for a loan. Once the total amount of net assets has been determined, simply divide by 240.

Here's an example: Joe Borrower has $2 million in gross assets. He is using $50,000 for closing.

$2,000,000 - $50,000 = $1,950,000 / 240 = $8125 (monthly income that can be used for qualification)

FNMA has slightly different guidance when it comes to calculating "employment-related assets as qualifying income." Just as FHLMC, it is important to determine the amount of total net assets that can be used. To accomplish this, the gross assets would need to be reduced by: 1) the amount needed for down payment, closing costs, and reserves, and 2) the amount of any penalty a borrower might incur from withdrawing on those accounts (such as an early withdrawal penalty on a retirement account). Once the total amount of net assets has been determined, that should be divided by the applicable term of loan in months. So, a 30-year mortgage would divide the assets by 360. A 15-year mortgage would divide the net assets by 180. The term will cause the total amount of qualifying income to vary significantly!

Here's another example using our scenario from Joe Borrower: Joe Borrower has $2 million in gross assets. He is using $50,000 for closing. He will also incur a 10% early withdrawal penalty from his employer IRA.

$2,000,000 - $200,000 (10% penalty for early withdrawal) = $1,800,000

$1,800,000 - $50,000 (closing costs) = $1,750,000 (net assets)

If Joe wants a 15-year mortgage, his total qualifying income would be $9,722.22/mo. $1,750,000 / 180 = $9,722.22

If Joe decides that he would rather have a 30-year mortgage to lower his monthly payment, his qualifying income would be reduced to $4,861.11/mo. $1,750,000 / 360 = $4,861.11

As you can tell, with FHLMC, the flat division by 240 across the board is simple. It also seems to hit a happy medium between the 15-year and 30-year calculations that would come up most often with FNMA. If utilizing a 15-year mortgage with FNMA, the buyer can potentially have a higher amount of qualifying income. If utilizing a 30-year mortgage with FNMA, the buyer will have significantly less buying power because of the calculation being divided over 360.

So, does FHLMC not care about early withdrawal penalties and that is why they are not part of the calculation? No. On the contrary, FHLMC does not include this early withdrawal in their calculation because they require the borrower to have access to withdraw the funds in their entirety, without being subject to a penalty. In other words, if a borrower is going to incur a penalty, FHLMC says those retirement assets cannot be used. FNMA will let you use them, but they have to take the penalty as part of the calculation (we used 10% above in our scenario, but this may differ and would need to be determined with each specific loan).

More to come on this topic as we wrap up how to use assets for qualifying income for both FNMA and FHLMC. The next part will have significantly less math!

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