Loan Officer Training 10/08/2024 - Mastering Variable Income for Loan Officers

In this episode of "Loan Officer Training," we’re tackling one of the trickiest challenges loan officers face: Mastering Variable Income. Whether you’re working with self-employed clients, freelancers, or anyone with fluctuating earnings, understanding how to effectively assess and manage variable income is crucial to expanding your client base and closing more deals.

Join our expert hosts as they break down the art of evaluating variable income, providing strategies and tools you need to navigate complex financial situations. We’ll cover everything from analyzing profit and loss statements to identifying patterns in irregular income streams and determining the best approach to qualify clients.

💡 What is variable income, and why is it so challenging for loan officers?
📈 Proven strategies for analyzing and calculating fluctuating income effectively.
📝 Tips for communicating with clients to gather the right financial documentation.
✅ How to increase your success rate by mastering underwriting with variable income.

Gain practical, actionable advice that will help you feel more confident when dealing with non-traditional borrowers. Learn how to transform these challenging applications into approved loans by understanding the key factors lenders look for and how you can present your clients’ finances in the best possible light.

If you want to take your skills to the next level and be the loan officer who can handle even the most complicated applications, this episode is a must-listen. Tune in to "Loan Officer Training" and become a master of variable income assessment—unlock new opportunities and build lasting success in your career!

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Transcript

Restream recording Oct 08, 2024 • 04:02:35 PM: 0:13

So welcome everyone. My name is Kyle Hiersche. I am the CEO of the Mortgage Calculator joined here by our president Nick Hiersche and our CSO Jose Gonzalez. We are a lender that specializes in non QM loans and what we do every Tuesday, Wednesday, Thursday at 12 p. m. Eastern is our loan officer training where we go through a new loan officer training topic, an in depth training, and today is going to be very important, mastering variable earnings. So I'll turn it over to Jose. I'm sure we probably got some great stuff to get into here. So go ahead and take it over. All right. Good afternoon or good morning everyone. For those of you on the West coast, since we do have quite a few MLOs on the West coast of the U S and actually even in Hawaii. So this is a good one because, uh, um, production is ramping up in the agency side. In the full doc type loans, right? I mean, uh, non Q. M. Alt doc has been totally popping the last 2 years, but now with the, uh, lowering of the rates, we are getting more interest in the full doc borrowers and definitely variable income is 1 of those categories that you have to be able to master. To be able to properly calculate, uh, income, right? Got to do a thorough income analysis. It's not just grab the pay stubs, uh, multiply the hourly rate by 40 hours, grab everything that's in there and you're done. No, you got to break them down. And that's what I'm going to assist you with you today in the theory. On how to analyze it, right? We're not so much going to look at, uh, show you how to calculate, but show you how to analyze so you know what you need to calculate. That's usually where, um, people, uh, miss a step, is they don't realize what they have to actually review. It's not so much the mechanics of the math, it's what you're actually analyzing. So let's break it down here. When we're talking about variable income, what are we actually referring to? And this is a critical point here, right? Variable income is income that is calculated by an averaging, that's the important word here, averaging method and can vary depending on the situation. Now, what we mean by that is in terms of averaging, depending what type of variable income you have. Is what you're going to average, right? Are you looking two years back or, uh, are you considering a year to date as well, or what's the probability of its continuance in the future, right? Those are all different considerations that you make depending on the type of variable income that we're analyzing. Now, it's very important to note that variable income is applicable To all borrower types, right? It's applicable to your hourly. borrower, it's applicable to your salaried borrower, and it's also applicable to your self employed borrowers. Uh, right, so it just depends on what the income stream is, uh, but there, there could be a variable component there. Uh, especially, right, with the self employed, their, their income alone itself is usually going to have to be averaged unless you pick a one year option for a non QM, or unless you happen to get the one year findings from AUS if it's an agency loan. Sorry, but Lincoln, excuse me, we're looking at. Commission, commission income, that's the most commonly known type of variable income. Tip income, right, that's a service industry type, uh, income. Bonuses for our salaried borrowers, but you could also be an hourly borrower getting a bonus. Overtime, which is going to be mainly for our hourly borrowers only. Commission could be for anybody. You could be hourly salaried or self employed. And be getting commissions from different types, um, automobile allowance. Now that's a tougher one to recapture because, uh, it would have to be taxed a taxable benefit, right? Automobile allowance, capital gains income. That's another of those categories that you have to be very careful if you're trying to use it, because you got to show up. A longer track record than usual. They might want you to go back three years instead of two years and show a good solid year to date and show a good solid letter of what's to come as well. Interesting come and dividends income, right? Those are all those last three are what's the probability of its continuance and you'll see when we get into the presentation now, but. Each of these types of variable income and, and the list is not limited just to this, but these are the most common ones. Uh, some get treated the same. Others get treated differently. And what's going to determine that is, are you just determining its continuance moving forward or, or you're also looking at the historical receipt of the amount as well, right? As far as your, your averaging goes. So what type of challenges. Do we face, uh, when we have a borrower with variable income? So again, here we're talking theory. This is not just how to crunch the numbers. Cause you know, that's, that's the easy part. This is how do you look at the data and. See and properly interpret what's actually going on and an unstable or downward trending income is a big red flag. That's a really bad one. If it's really deep, like if you had 2022 income of 200, 000 and 2023 income of 53, 000. Maybe the 53, 000 still allows your borrower to qualify because they realize, listen, okay, I understand. Then let me just get the house. That's 200 or 250 or whatever they qualify for. But the underwriter is going to look at that income and the under is going to say, wait, hold on a minute, Jose, we got a big red flag. This income has decreased by like 300 percent from 200, 000 to 53, 000 or whatever the percentage of decrease may be. We need a really good explanation as to what is the reason that the income has to come so drastically. Because we need to make a determination as to, is this company even going to be existing? A year from now, if this downward trend is still going down, they're at 53. Now, where will they be next year? At 20, right? That's the kind of quest that's, what's going to be going through the underwriters mind, so there's going to have to be some good documentation provided there by the borrower and by their accountant and good explanations as to what is really going on, you know? Uh, so it's really, uh, maybe they just did a realignment or something. Maybe they sold off one of the divisions, but they kept another division. So whatever it is. It needs to be properly documented because the figure is too low. The underwriter may just say, may just deny the loan based on the unstable and declining trend. Uh, documentation must support a history of receipt of the income, uh, to be able to also document the amount, the frequency, and the duration of the income. So you're going to look at a history of the receipt of the income and then within that historical data that you have. You're going to see, okay, with each payment, uh, where they paid every month, where they paid every three months, or they paid every six months, where they paid once a year, uh, once every two years, how much were they paid, and paid for, is there a duration, is there an expiration to this, so there, that may be available on the document that supports why they're They're even receiving that. Uh, so, but on the other hand, if, if the needed history is not provided, or the amounts do not support the value, in other words, the income that we're calculating, then the income is either going to be adjusted to the proper level. Or may not be able to be used at all if it's deemed to be too sporadic and not, uh, on a, you know, continual basis. Those are all things. Mind you, we're just looking at the data here. We're not even looking at the amount. We're not looking at the DTI. We're just looking at it since it is variable income. Are we even going to be able to use it and what do we need to provide to be able to properly document it and take into consideration, uh, these issues, potential issues that we're facing here, which takes us to now, excuse me, uh, category number three, continuity. Of income. Now, notice this one. We've divided into two categories. Well, not we, but it is divided into two categories. One would be a type of continued type of income with no defined expiration date. There's no contract to it. It's just something that's happening like capital gains where your borrowers, either flipping homes to get co gains or maybe selling stocks, trading stocks to get capital gains or a foreign exchange to get capital gains. Whatever that activity is, you're going to need to document at least 24 months history. Now, less time may be considered within between 12 and 24 months of receipt may be considered, but that's a maybe a given is going to be 24. In some cases, they may ask you for 36. They want to go further back in time to see not so much the money that they're going to calculate using the third year back, but just looking at the trend and looking at the borrow during the activity. So capital gains, bonuses, overtime, or commissions, those are all variable income types with no defined expiration date. There's, you know, there's no real contract that says, usually at least that says you're going to work 20 hours of overtime every week at your overtime rate. There may be. In some cases, but that's not usual and customary, nor do you know how much commission you're going to be getting. You only know your percentage, but you don't know how many deals you're going to get. So all of that, uh, no defined expiration date. You do need historical data to confirm receipt of the item, and then you need to document how much has been received, and do your calculations, and then get your year to date numbers to see if the trend is the same. All of those are, or, um, Uh, uh, different things to be analyzed when you don't have a defined expiration date. And then conversely, we have, which this is a little bit easier now, if you have an income stream tied to a defined expiration date, like for example, notes receivable, right? You lend, you lend somebody some money and you, they sign a note of that they're, you know, you, A note receivable and you know that for the next 5 years, you're supposed to receive 100 a month, which is whatever 80 principal 20 interest for the next 5 years, 60 payments. So, and right now we're in month, uh, 14 of the agreement, so, you know, you have, uh, whatever, uh, 30, 46 months, I guess to left. So that's definitely 3 or more years continuance. For an income stream with a defined expiration date, always minimum three more years. So, notes receivable could be one. Pension plan or retirement distributions is another very popular, very popular one. Or royalty payments, right? You sold a business. And they're paying you every year, a certain percentage, uh, for a defined amount of time, according to the sales contract, you know, when you sold them your business. So that's another one. You have to look at the contract and see until when the income stream will be active and make sure that it's at least three more years of continuance. And now I'm. Touching here a little bit more on pension plans, right? Pension plans and retirement plan distributions in general, because this is the one that we see a lot and you just have to understand now. In the context that we're seeing here that because a pension plan has a defined expiration date at some point, the expiration date can be upon the death of the beneficiary, right? It's the, our individual borrower, uh, some pension plan they have from whenever they work somewhere else, right? But you're still going to need. The terms and conditions of the pension plan to determine that it's, it's going to continue for at least three more years, we will need something in writing from somebody, preferably from some type of a handbook or manual or something where it says, or maybe the, the actual agreement that they have when they were enrolled in the pension plan that says until when they're going to receive. That benefit that is key. So whenever you do have anybody, they give you a 10 99 for a pension plan. Uh, please ask them for that information because you will need that information for a pension plan. Don't hold your deal up on that. So, um, Lastly, here, we talk about some more solutions with no defined expiration date, right? Because these are the ones that are a little bit tougher for us to deal with, right? The overtime, the commission, the bonuses. Right, uh, with no defined expiration date is very difficult. That's why always when we're reviewing those files and we see those paste stubs. Like for the nurses, for example, everyone knows the nurses pay stubs. Those are the one of the more complicated pay stubs you're going to see because they got their, their base pay, education, overtime, uh, shift differential, night shift differential. Holiday differential. I mean, then they got some paid time off and a little bit of vacation time thrown in there. And I mean, it's all sorts of stuff. You could have 10, 11, 12, uh, categories in a paste of, uh, and what is base pay and what is other and what is variable pay, right? That's where you got to get some clarification. The bar needs to get some clarification from their HR. Sometimes they can even provide you like, uh, some kind of a document that And it explained pretty clearly, but do be aware that when you do have those complicated variable income situation, the one of the best. Uh, things you can do right away is order a written verification of employment, W. V. O. E. the written, you know, get that borrower certification and authorization signed and send it along with the written verification of employment to the whoever is the authorized contact to complete the form of the employer, or maybe the employer uses one of the third party verification services Uh, fine. They'll just need to let you know, that's what they do. You send it to the appropriate service. You get your written verification of employment, and it's going to have a broken down for you nicely. Base pay, overtime, bonus, and. Other as applicable, right? Like for the, uh, in, um, education reimbursements usually go on the other. So then the good thing is you're going to have the historical data. Usually they've been at that employment. If not, you need to get written verifications to go up, cover a total of two years for that variable income. Right. Uh, so hopefully they'll have it covered if they, if the bar has been there. At least two years. You have your breakdown of everything. Is this continuance likely? Which is one of the questions on the written verification of employment for bonus and for overtime. Average hours worked per week and even box 20 for some remarks that they may want to put. Sign it, return it to you, and now you can properly calculate the variable income for your borrower without any doubts. Always best to submit, have that written verification form up front before you submit. To underwriting so that you don't get a lot of needless conditions. Now it's sometimes, uh, you don't have time, but you have the year end pay stubs. That's good. If it's not too complicated of an income, like for a nurse, if all you're dealing with is overtime bonus and base pay. Then that's fine. If you have the year and pay subs for, for example, 2022 then you have the year today, 2024, you can make some good calculations there. Uh, if there's no again, and if there's no gray areas regarding what type Uh, category we're talking about and is it base pay or is it other so now when you do have some defined expiration dates, uh, it's going to be a lot easier because then you're going to be looking at the actual document. Right. The note receivable is going to tell you when the income is going to end. The royalty income is going to be based on the sales contract. It's going to tell you when the income is going to end. And if it's, uh, like a restricted stock income, that's a one time event. Usually not going to be a recurring event. And last but not least, You know, the tip income is the one that's going to be hard to document, uh, anywhere other than tax returns. That's it. Tax returns. There's no other way to document that tip income. If they don't claim it on the tax returns, if you're going with a full doc borrower. Now, in some cases, right, there's always a little bit of an exception in some cases in some companies where they pay their employees a certain percentage, they'll pay them a base salary. Uh, hourly and then they'll pay them, uh, a certain percentage in tips and they actually pay those with a W 2. Now they may still receive cash tips that they have to declare. These would be tips that were paid, uh, included, for example, with a credit card. Customer tips, uh, with through the credit card, they're going to get that as tip income. And then that case, it is put in the, um, W2 in a separate category sometimes as a tips income. So just to be aware of that. I, I just had that recently with, uh, a chef. Where he had his base pay, and then he received, um, I don't know, I guess tips that they give to the service staff, including the chef. So he had his extra tips income. And then on top of that, he was declaring a little bit extra. I guess he knew last year he was going to buy a house. Right? Last two years, though, he declared even a little bit extra, um, both for the cash portion that he received in tips income. And we were able to qualify him because he was declaring the income. But if it's not on the W 2 and it's not on the tax return, Uh, then, you know, the only way you're going to be able to capture it somehow is through some type of, uh, self employed type program for self employed borrowers, where you're looking at bank statements, but if they're not a self employed borrower, then that's not going to be an option. So do be aware, uh, how we can verify, you know, what are the solutions to all of these different verifications. Do be aware that, uh, you know, how we analyze, uh, the no defined expiration date versus a defined expiration date. And that's going to determine the type of documentation that you need. So hope, hopefully this has made the math, uh, simpler. For you all, because now you know exactly what you'll need to analyze for your borrower. And remember, if they are self employed, do look, uh, not just for the Schedule C's on the 1040, but also look to see if they have a partnership with someone where they're going to receive a 1065. Report or if they actually have a vested interest in an S corp where they're going to also receive an 1120s. Hope this helps to serve income borrowers. All right. Thank you, Jose. Great information there. I don't see any questions yet, but definitely very important stuff to know. And of course this is recorded and on our YouTube channel so you can always watch it when you do come across a borrower with this type of variable income and make sure So I still don't see any questions. We'll go ahead and wrap it up. Remember that we do this training on every Tuesday, Wednesday, and Thursday at 12 p. m. Eastern where we go through a loan officer training topic and a deep dive into it. So we will be back here tomorrow at, uh, 12 p. m. Eastern for the next episode of the Loan Officer Training Series with the Mortgage Calculator. Thank you everyone. Have a great day.