Why Haven’t Loan Officers Been Told These Facts?
Part II, How to Underwrite A Temporary Reduction in Employment Income According to FNMA
Last week, the Journal unpacked the FHA policy surrounding temporary reduction in employment income. Lenders encounter various types of leave from employers. Differentiating the nature of the income change is critical to selecting the applicable investor policy. For starters, the MLO must discern the type of employment change the subject is experiencing. Common to employees are the following changes to employment:
- Layoff
- Furlough
- Long-term disability (Private Insurance)
- Short-term disability (Private Insurance)
- Public disability benefits
- Family leave
- Medical leave
When the employer anticipates a near-term return to work, instead of the layoff, they use the furlough. A furlough differs from a layoff in that a furloughed employee is still an employee, while a layoff terminates the employment relationship. Furloughs may take many forms depending on whether the employee is salaried or hourly.
Exempt employees (salaried) must be paid their full salary for any week they work, regardless of the hours. Employers can generally furlough salaried employees in weekly increments at a minimum. Typically, exempt employees are prohibited from doing any compensable work while furloughed.
Employers have different rules for hourly employees on furlough. For example, an employee working a 40-hour week may asked to work 20 hours per week for the next 60 days. When the furlough period ends, the employees resume the typical work week.
However, and importantly, FNMA and FHLMC treat furloughs differently than other types of reduction in employment income, though the furlough is often temporary leave. In a nutshell, determining the stability of a furloughed employee’s income is difficult. In many cases, a furlough screams uncertainty and instability.
Leave and reduction in income, when temporary and falling favorably within the investor policies, may allow the lender to impute an income from available cash reserves.
As FHLMC states, “Leave ceases being considered temporary when the Borrower does not intend to return to the current employer or does not have a commitment from the current employer to return to employment.” However, that does not apply to furloughs and certainly not layoffs. Yet, unemployment income can be considered stable in some cases.
Long- and short-term disability income from private insurers may also be considered stable under specific circumstances with the appropriate documentation. Public disability benefits have separate rules.
This article focuses on a narrower segment of employment income interruption—situations when the lender may favorably consider that the employee will return to work and normative pay.
From FNMA B3-3.1-09, Other Sources of Income (05/01/2024)
Temporary leave from work is generally employee-initiated, short in duration and for reasons including, but not limited to maternity or parental leave, short-term medical disability, or other temporary leave types that are acceptable by law or to the borrower’s employer. Borrowers on temporary leave may or may not be paid during their absence from work.
Note: Mandatory leave initiated by an employer, such as a furlough or layoff, is not considered temporary leave regardless of an expected return to work date. For income from unemployment benefits received as a result of mandatory leave initiated by an employer, see Public Assistance Income above.
If a lender is made aware that a borrower will be on temporary leave at the time of the loan closing and that borrower’s income is needed to qualify for the loan, the lender must determine allowable income and confirm employment as described below.
The borrower’s employment and income history must meet standard eligibility requirements as described in Section B3–3.1, Employment and Other Sources of Income.
The borrower must provide written confirmation of their intent to return to work.
The lender must document the borrower’s agreed-upon date of return by obtaining, either from the borrower or directly from the employer (or a designee of the employer when the employer is using the services of a third party to administer employee leave), documentation evidencing such date that has been produced by the employer or by a designee of the employer.
Examples of the documentation may include, but are not limited to, previous correspondence from the employer or designee that specifies the duration of leave or expected return date or a computer printout from an employer or designee’s system of record. (This documentation does not have to comply with the Allowable Age of Credit Documents policy.)
The lender must receive no evidence or information from the borrower’s employer indicating that the borrower does not have the right to return to work after the leave period.
The lender must obtain a verbal verification of employment in accordance with B3-3.1-07, Verbal Verification of Employment. If the employer confirms the borrower is currently on temporary leave, the lender must consider the borrower employed.
The lender must verify the borrower’s income in accordance with Section B3–3.1, Employment and Other Sources of Income. The lender must obtain:
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- The amount and duration of the borrower’s “temporary leave income,” which may require multiple documents or sources depending on the type and duration of the leave period; and
- The amount of the “regular employment income” the borrower received prior to the temporary leave. Regular employment income includes, but is not limited to, the income the borrower receives from employment on a regular basis that is eligible for qualifying purposes (for example, base pay, commissions, and bonus).
Requirements for Calculating Income Used for Qualifying
If the borrower will return to work as of the first loan payment date, the lender can consider the borrower’s regular employment income in qualifying.
If the borrower will not return to work as of the first loan payment date, the lender must use the lesser of the borrower’s temporary leave income (if any) or regular employment income. If the borrower’s temporary leave income is less than their regular employment income, the lender may supplement the temporary leave income with available liquid financial reserves (see B3-4.1-01, Minimum Reserve Requirements). The following are instructions on how to calculate the “supplemental income”:
Supplemental income amount = available liquid reserves divided by the number of months of supplemental income
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- Available liquid reserves: subtract any funds needed to complete the transaction (down payment, closing costs, other required debt payoff, escrows, and minimum required reserves) from the total verified liquid asset amount.
- Number of months of supplemental income: the number of months from the first loan payment date to the date the borrower will begin receiving their regular employment income, rounded up to the next whole number.
After determining the supplemental income, the lender must calculate the total qualifying income.
Total qualifying income = supplemental income plus the temporary leave income
The total qualifying income that results may not exceed the borrower’s regular employment income.
Example
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- Regular income amount: $6,000 per month
- Temporary leave income: $2,000 per month
- Total verified liquid assets: $30,000
- Funds needed to complete the transaction: $18,000
- Available liquid reserves: $12,000
- First payment date: July 1
- Date borrower will begin receiving regular employment income: November 1
- Supplemental income: $12,000/4 = $3,000
- Total qualifying income: $3,000 + $2,000 = $5,000
Note: These requirements apply if the lender becomes aware through the employment and income verification process that the borrower is on temporary leave. If a borrower is not currently on temporary leave, the lender must not ask if they intend to take leave in the future.
The FHLMC requirements are essentially the same as FNMA. However, they may differ. Consequently, ensure the application of the correct policies.
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BEHIND THE SCENES – First Generation Buyer Programs
Fannie Mae is working with housing industry stakeholders to facilitate a collaborative effort to drive future adoption and use of a GSE “first-generation” definition within existing and new market-developed programs.
Special mortgage-backed securities or bonds will support these programs. Additionally, the GSEs intend to incentivize sellers with pricing incentives and other devices aimed at making low-moderate income mortgages more feasible for lenders and financing more affordable for homebuyers. Yay!
Thank you, Director Thompson, FNMA CEO Priscilla Almodovar, and the many fine folks at the GSEs fighting for housing affordability. Creative efforts such as the Social Bond Framework are steps in the right direction. There is no silver bullet for housing affordability. It takes many small steps to significantly attenuate housing barriers for underserved communities. These are truly good works. Next up, get cracking on more sponsorship for multi-generational homes. Keep it up!
FNMA First-Generation Homebuyer Fact Sheet
Tip of the Week – No Right to Cancel Refinance Transactions
§ 1026.23(f) Refinancing Right of Recession Exempt
Same Originator – No Right To Cancel With No Cash-Out Transactions
The exemption in § 1026.23(f) applies only to refinancings (including consolidations) by the original creditor. The original creditor is the creditor to whom the written loan agreement was initially made payable.
The right of rescission shall apply to the extent the new amount financed exceeds the unpaid principal balance, any earned unpaid finance charge on the existing debt, and amounts attributed solely to the costs of the refinancing or consolidation.
For purposes of the right of rescission, a new advance does not include amounts attributed solely to the costs of the refinancing. In determining whether there is a new advance, a creditor may rely on the amount financed, refinancing costs, and other figures stated in the latest Truth in Lending disclosures provided to the consumer and is not required to use, for example, more precise information that may only become available when the loan is closed.
To illustrate, if the sum of the outstanding principal balance plus the earned unpaid finance charge is $500,000 and the new amount financed is $501,000, then the refinancing would be exempt if the extra $1,000 is attributed solely to costs financed in connection with the refinancing.