Written By: Frankie Lacy, Op-Ed Writer
There are many income types that may be non-taxable income earned by the borrower. Some examples are:
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-Military allotments
-Social security
-Retirement income
-Interest and dividend earnings
Some of this income may be “grossed up” to use a higher amount for qualification purposes. However, certain steps must be taken to verify the non-taxable status of this income AND the proper percentage to use for the “gross up” calculation.
To verify the non-taxable status of income, tax returns or the military leave and earnings statement must be reviewed. The difference between the total income earned and the total taxable income amount is the non-taxable portion of the income that can be grossed up. For example: If the tax returns show $20,000 total social security earnings and $13,000 of taxable social security earnings, the total non-taxable portion that can be grossed up is $7,000 for that tax year.
The next step is to determine the tax bracket for each tax year. This can be accomplished by looking up the tax information on http://www.bankrate.com/finance/taxes/tax-brackets.aspx. Some originators make the mistake of using a blanket 25% tax bracket for all loans. Many borrowers will fall in the 15% tax bracket, especially those on fixed income.
Using the same example, we would then multiply the non-taxable portion by 115% or 125% (or whatever matches the tax bracket): $7,000 X 115% = $8,050. This figure represents the total non-taxable income amount that can be used to qualify for that tax year. Once you have calculated the non-taxable amount for two years, you must perform a 24 month average to determine the amount you can use to qualify.
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It is important to note that a two year history of non-taxable income is usually required. A 12 month history can be used on an exception basis. The underwriter must also confirm the likelihood that this non-taxable income will continue for at least three years if using to qualify. If there is any indication that the non-taxable status of the income will not be continuing, the income should not be grossed up to qualify.
About The Author
Frankie Lacy - As an op-ed writer, Ms. Frankie Lacy is a 15+ year mortgage industry veteran with extensive conventional mortgage underwriting experience. Topics of Frankie's expertise include: Fannie Mae, Freddie Mac, USDA Rural Housing, underwriting to investor overlays, self-employed borrowers, personal and business tax return analysis, rental income, condos/co-ops/PUDs, and more. Frankie is a Davenport University graduate with a degree in Business Administration.
