Standards for Determining Monthly Debt and Income Appendix Q

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1 Standards for Determining Monthly Debt and Income Appendix Q October Genworth Financial, Inc. All rights reserved. Agenda What we will cover General Income Requirements Documentation Requirements Genworth Website Helpful tools 1 1

2 The Rule CFPB s Ability-to-Repay (ATR) Rule Final CFPB rule, effective January 10, 2014, requires mortgage lenders to consider consumers ability to repay loans before extending credit Excludes open-end credit, timeshare plans, reverse mortgages and certain temporary loans 2 Ability-to-Repay (ATR) Rule Key concepts of the new rule: The creditor must make a reasonable and good faith determination that the consumer has the ability to repay the loan. Mortgage borrowers must provide ample financial documentation; lenders must verify the documents. In order to be approved for a particular home loan, the borrower must have sufficient income and assets to repay the loan. 3 2

3 Ability-to-Repay (ATR) Rule At minimum, creditors must consider: 1. Current or reasonably expected income or assets 2. Current employment status 3. Monthly payment on the covered transaction 4. Monthly payment on any simultaneous loan 5. Monthly payment for mortgage-related obligations 6. Current debt obligations, alimony, and child support 7. Monthly debt-to-income ratio or residual income 8. Credit history Creditors must verify the information using reliable third party records Appendix Q contains the standards for determining monthly debt and income. 4 Qualified Mortgages (QM) Appendix Q Provides guidance for determining Monthly Debt and Income 5 3

4 Amendments to Appendix Q 6 Qualified Mortgages (QM) Generally, a QM loan has: (i) substantially equal monthly payments, (ii) a loan term <= 30 years, (iii) points and fees that do not exceed 3%, (iv) been underwritten using the maximum interest rate that may apply during the first 5 years (and with amortizing monthly payments), 7 4

5 Qualified Mortgages (QM) (v) the creditor considers and verifies the borrower s income, assets and debts in accordance with Appendix Q, and (vi) a DTI that does not exceed 43%. However, for loans that are eligible for purchase by Fannie or Freddie, FHA, VA, USDA, Rural Housing Service, a mortgage is a QM loan if it meets conditions (i)-(iii) above. Note the loan only needs to be eligible for purchase; actual sale to Fannie/Freddie isn t required. 8 Income Requirements Appendix Q gives guidance on determining the Stability and Eligibility of a consumers income. This guidance may differ from your current investors such as: Fannie Mae, Freddie Mac, FHA, VA Please also be aware that your internal guidelines may also currently differ. Effective income is: Verifiable Steady, Stable or increasing Likely to continue into the future Only Effective Income May Be Used In Qualifying 9 5

6 Verifying Employment History Two year history is required on the 1003 for all applicants All Gaps Of Employment Must Be Addressed By The Applicant And Reviewed By The Creditor 10 Verifying Employment History Consumers must: Explain any gaps in employment that span one or more months, and Indicate if he/she was in school or the military for the recent two full years, providing evidence supporting this claim, such as college transcripts, or discharge papers. Allowances Can Be Made For Seasonal Employment If Documented By The Creditor 11 6

7 Verifying Employment History Examine probability of continued employment: The consumer s past employment record Qualifications for the position Previous training and education; and The employer s confirmation of continued employment Income Stability Takes Precedence Over Job Stability 12 Verification of Employment (VOE) 13 7

8 Verifying Employment History If consumer is returning to work after an extended absence, income can be considered if: Applicant is employed in the current job for six months or longer; and A two year work history prior to an absence from employment has been documented using: Traditional employment verifications; and/or Copies of IRS Form W-2s or pay stubs. Extended Absence Is Defined As Six Months 14 Verifying Employment/Income History Salary and Wage Earnings: The income of each consumer who will be obligated for the mortgage debt must be analyzed to determine whether his/her income level can be reasonably expected to continue through at least the first three years of the mortgage loan Effective income for consumers planning to retire during the first three-year period must include the amount of: a. Documented retirement benefits; b. Social Security payments; or c. Other payments expected to be received in retirement. Creditors Must Not Ask The Consumer About Possible, Future Maternity Leave 15 8

9 Verifying Employment/Income History Overtime and Bonus Income can be considered: If the consumer has received this income for the past two years, and it will likely continue The creditor must develop an average of bonus or overtime income for the past two years. If either type of income shows a continual decline, the creditor must document in writing a sound rationalization for including the income when qualifying the consumer A Period Of More Than Two Years Must Be Used In Calculating The Average Overtime And Bonus Income If The Income Varies Significantly From Year To Year 16 Verifying Employment/Income History Part Time and Seasonal Income: Part-time and seasonal income can be considered in qualifying the consumer if the creditor documents that the consumer has worked the part-time job uninterrupted for the past two years, and plans to continue Seasonal income is considered uninterrupted, and may be used to qualify the consumer, if the creditor documents that the consumer: Has worked the same job for the past two years, and Expects to be rehired the next season. Part-time Income Refers To Employment Taken To Supplement The Consumer s Income From Regular Employment; Par-time Employment Is Not A Primary Job And It Is Worked Less Than 40 Hours 17 9

10 Verifying Income History Income: Commission Commission income must be averaged over the previous two years Must be stable and likely to continue To qualify commission income, the consumer must provide: Copies of signed tax returns for the last two years; and The most recent pay stub Unreimbursed Business Expenses Must Be Subtracted From Gross Income 18 Verifying Income History Income: Other Retirement income must be verified from the former employer, or from Federal tax returns If any retirement income, such as employer pensions or 401(k) s, will cease within the first full three years of the mortgage loan, such income may not be used in qualifying Social Security income must be verified by the Social Security Administration If any benefits expire within the first full three years of the loan, the income source may not be used in qualifying The creditor must obtain a complete copy of the current awards letter. Not all Social Security income is for retirement-aged recipients; therefore, documented continuation is required. Some portion of Social Security income may be grossed up if deemed nontaxable by the IRS

11 Does your borrower own 25% or more of a business? 20 Verifying Employment/Income History Self Employed: Income from self-employment is considered stable, and effective, if the consumer has been self-employed for two or more years Review for declining income trends Self-employed consumers must provide the following documentation: Signed, dated individual tax returns, with all applicable tax schedules for the most recent two years; For a corporation, S corporation, or partnership, signed copies of Federal business income tax returns for the last two years, with all applicable tax schedules; Year to date profit and loss (P&L) statement and balance sheet; and Consumers With 25% Or Greater Ownership Interest In A Business Are Considered Self-Employed 21 11

12 Verifying Employment/Income History Self Employed Continued: Establishing a Consumer s Earnings Trends Establish the consumer s earnings trend from the previous two years using the consumer s tax returns. Documentation from the Consumer Quarterly tax returns, the income analysis may include income through the period covered by the tax filings, or P&L statement may be included in the analysis, provided the income stream based on the P&L is consistent with the previous years earnings. If the P&L statements show an income stream considerably greater income, the creditor must base the income analysis solely on the income verified through the tax returns. If the earnings trend is downward and the most recent tax return or P&L is less than the prior year s tax return, the consumer s most recent year s tax return or P&L must be used to calculate his/her income. The creditor may need to determine the likelihood of the income continuing on a downward trend. 22 Verifying Employment/Income History Self Employed Continued: Analyzing the Business Financial Strength Review the Source of the business income; Annual earnings that are stable or increasing are acceptable, while businesses that show a significant decline in income over the analysis period are not acceptable

13 Verifying Income History Income Analysis: Individual Tax Returns (IRS Form 1040): Analyzing the Individual 1040 General Policy on Adjusting Income Based on a Review of IRS Form The amount shown on a consumer s IRS Form 1040 as adjusted gross income must either be increased or decreased based on the creditor s analysis of the individual tax return and any related tax schedules. 24 Guidelines for Analyzing IRS Form 1040 The table below contains guidelines for analyzing IRS Form

14 Guidelines for Analyzing IRS Form 1040 The table below contains guidelines for analyzing IRS Form Guidelines for Analyzing IRS Form 1040 The table below contains guidelines for analyzing IRS Form

15 Verifying Income History Self Employed Continued: Corporate Tax Returns (IRS Form 1120) Obtain Consumer Percentage of Ownership Information Analyzing Corporate Tax Returns: To determine a consumer s self-employed income from a corporation the adjusted business income must: Be determined; and Multiplied by the consumer s percentage of ownership in the business The table on the next slide describes the items found on IRS Form 1120 for which an adjustment must be made in order to determine adjusted business income A Corporation Is A State-Chartered Business Owned By Its Stockholders 28 IRS Form 1120 Adjustment Chart 29 15

16 Verifying Employment/Income History Self Employed Continued: S Corp Tax Returns (IRS Form 1120S) An S corporation is generally a small, start-up business, with gains and losses passed to stockholders in proportion to each stockholder s percentage of business ownership Income for owners of S corporations comes from IRS Form W-2 wages, and is taxed at the individual rate. The IRS Form 1120S, Compensation of Officers line item is transferred to the consumer s individual IRS Form 1040 S corporation depreciation and depletion may be added back to income in proportion to the consumer s share of the corporation s income. Income must also be reduced proportionately by the total obligations payable by the corporation in less than one year A Consumer s Withdrawal Of Cash From The Corporation May Have A Severe Negative Impact On The Corporation s Ability To Continue Operating, And Must Be Considered 30 Verifying Employment/Income History Self Employed Continued: Partnership Tax Returns (IRS Form 1065) A partnership is formed when two or more individuals form a business, and share in profits, losses, and responsibility for running the company Each partner pays taxes on his/her proportionate share of the partnership s net income; partnership depreciation and depletion may be added back to income in proportion to the consumer s share of the partnership s income The Consumer s Withdrawal Of Cash From The Corporation May Have A Severe Negative Impact On The Corporation s Ability To Continue Operating, And Must Be Considered 31 16

17 Verifying Employment/Income History Self Employed Continued: Partnership Tax Returns (IRS Form 1065) General and limited partnerships report income on IRS Form 1065, and the partners share of income is carried over to Schedule E of IRS Form Review IRS Form 1065 to assess the viability of the business. Both depreciation and depletion may be added back to the income in proportion to the consumer s share of income. Income must also be reduced proportionately by the total obligations payable by the partnership in less than one year A Consumer s Withdrawal Of Cash From The Corporation May Have A Severe Negative Impact On The Corporation s Ability To Continue Operating, And Must Be Considered 32 IRS Form 4506-t IRS 4506-t or similar forms Allows lenders to obtain transcripts of the tax returns for borrowers for free. Once signed and dated by applicant the form is good for 120 days or 8821 may also be used in lieu of the 4506-t but these forms typically cost to execute. Fannie Mae and Freddie Mac both have policies in place regarding the use of the form during processing

18 Verifying Employment/Income Business: Employed by Family Owned Income Documentation Requirement. In addition to normal employment verification, a consumer employed by a family owned business is required to provide evidence that he/she is not an owner of the business, which may include: Copies of signed personal tax returns, or A signed copy of the corporate tax return showing ownership percentage 34 Verifying Non-Employment Income INCOME: NON-EMPLOYMENT RELATED CONSUMER Alimony,, Alimony Child Support, and Maintenance Income Criteria. child support, or maintenance income may be considered effective, if: Payments are likely to be received consistently for the first three years of the mortgage The consumer provides the required documentation, which includes a copy of the: Final divorce decree; Legal separation agreement; A Court order; or Voluntary payment agreement; and A The consumer can provide acceptable evidence that payments have been received during the last 12 months, such as: Cancelled checks; Deposit slips; Tax returns; or Court records Child Support May Be Grossed Up Under The Same Provisions As Non-taxable Income Sources 35 18

19 Verifying Non-Employment Income NON-EMPLOYMENT RELATED CONSUMER INCOME: Investment and Trust Income Interest and dividend income may be used as long as tax returns or account statements support a two-year receipt history This income must be averaged over the two years. A Subtract any funds that are derived from these sources, and are required for the cash investment before calculating projected income Income from trusts may be used if guaranteed, constant payments will continue for at least the first three years of the mortgage term Required trust income documentation includes a copy of the Trust Agreement or other trustee statement, confirming the: Amount of the trust; Frequency of distribution; and Duration of payments. Trust account funds may be used for the required cash investment if the consumer provides adequate documentation that the withdrawal of funds will not negatively affect income. 36 Verifying Non-Employment Income NON-EMPLOYMENT RELATED CONSUMER INCOME: Eligible Investment Properties (Subject of your transaction) Follow the steps in the table below to calculate an investment property s income or loss if the property to be subject to a mortgage is an eligible investment property

20 Verifying Non-Employment Income NON-EMPLOYMENT RELATED CONSUMER INCOME: Rental Income (Other owned properties) Rent received for properties owned by the consumer is acceptable as long as the creditor can document the stability of the rental income through: A current lease; An agreement to lease, or A rental history over the previous 24 months that is free of unexplained gaps greater than three months (such gaps could be explained by student, seasonal, or military renters, or property rehabilitation). The underwriting analysis may not consider rental income from any property being vacated by the consumer, except under the circumstances described on the next slides. Rental Income From Any Property Being Vacated By The Consumer May Not Typically Be Considered 38 Verifying Non-Employment Income When a consumer vacates a principal residence in favor of another principal residence, the rental income, reduced by the appropriate vacancy factor, may be considered in the underwriting analysis under the circumstances listed in the table below. Exception Regarding The Exclusion Of Rental Income From A Principal Residence Being Vacated By A Consumer 39 20

21 Verifying Non-Employment Income When a consumer vacates a principal residence in favor of another principal residence, the rental income, reduced by the appropriate vacancy factor, may be considered in the underwriting analysis under the circumstances listed in the table below. Exception Regarding The Exclusion Of Rental Income From A Principal Residence Being Vacated By A Consumer 40 Verifying Non-Employment Income NON-EMPLOYMENT RELATED CONSUMER INCOME: Rental Income from Consumer Occupied Properties (Multi-family) The rent for multiple unit property where the consumer resides in one or more units and charges rent to tenants of other units may be used for qualifying purposes Projected rent for the tenant-occupied units only may: Be considered gross income, only after deducting vacancy and maintenance factors, and Not be used as a direct offset to the mortgage payment. Reduce The Gross Rental Amount By 25 Percent For Vacancies And Maintenance 41 21

22 Verifying Non-Employment Income Verifying Rental Income: IRS Form 1040 Schedule E and Current leases/rental agreements are required to verify all consumer rental income Analyzing IRS Form 1040 Schedule E: The IRS Form 1040 Schedule E is required to verify all rental income. Depreciation shown on Schedule E may be added back to the net income or loss. Income Positive rental income is considered gross income for qualifying purposes, while negative income must be treated as a recurring liability. The Creditor Must Confirm That The Consumer Still Owns Each Property Listed, By Comparing Schedule E With The REO Section Of The URLA 42 Verifying Non-Employment Income Verifying Rental Income: IRS Form 1040 Schedule E and Current leases/rental agreements are required to verify all consumer rental income. Using Current Leases To Analyze Rental Income Review the current signed lease or other rental agreement for a property that was acquired since the last income tax filing, and is not shown on Schedule E. Reduce the gross rental amount by 25 percent for vacancies and maintenance; Subtract PITI and any homeowners association dues; and apply the net if positive, or recurring debts, if negative 43 22

23 Verifying Non-Employment Income INCOME: NON-EMPLOYMENT RELATED CONSUMER Other See Appendix Q for guidance on other types of income such as: Military Income VA Benefits MCC s Notes Receivable Government Assistance Programs Homeownership Subsidies Income from Roommates Conversion of current Primary Residence Non Taxable and Projected Income 44 Consumer Liabilities: Recurring Obligations : Obligation Types of Recurring Recurring obligations include: loans;. a All installment accounts;. b Revolving charge loans;. c Real estate Alimony;. d. e Child support; and. f Other continuing obligations 45 23

24 Consumer Liabilities: Recurring Obligations Debt to Income Ratio Computation for Recurring Obligations The creditor must include the following when computing the debt to income ratios for recurring obligations: Monthly housing expense; and Additional recurring charges extending ten months or more, such as a. Payments on installment accounts; b. Child support or separate maintenance payments; c. Revolving accounts; (if no payment is listed on the credit report and a balance is listed use the greater of 5% or $10. A payment from a current statement may also be used) and d. Alimony (creditor may choose to treat as a reduction of income) e. Contingent liabilities (unless exempt) Debts Lasting Less Than Ten Months Must Be Included If The Amount Of The Debt Affects The Consumer s Ability To Pay 46 Additional Resources GENWORTH RESOURCES ActionCenter : Your Local Genworth Underwriting Manager Your Genworth Account Executive or Manager 47 24

25 Disclaimer Genworth Mortgage Insurance is happy to provide you with these training materials. While we strive for accuracy, we also know that any discussion of laws and their application to particular facts is subject to individual interpretation, change, and other uncertainties. Our training is not intended as legal advice, and is not a substitute for advice of counsel. Your legal counsel should be consulted regarding the requirements and applicability of Dodd-Frank and the CFPB Rules. GENWORTH EXPRESSLY DISCLAIMS ANY AND ALL WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE, WITH RESPECT TO THESE MATERIALS AND THE RELATED TRAINING. IN NO EVENT SHALL GENWORTH BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, PUNITIVE, OR CONSEQUENTIAL DAMAGES OF ANY KIND WHATSOEVER WITH RESPECT TO THE TRAINING AND THE MATERIALS. 48 Thank you! Genworth Financial is the NAFCU Services Preferred Partner for Private Mortgage Insurance. More educational resources are available at Talk to you next year! That MI Guy! https://www.facebook.com/thatmiguy 49 25

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