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FHA-insured loans are always considered full documentation (doc) loans. A full doc loan requires all income to be fully documented, whereas alt-doc loans can accept stated income. Other than FHA Streamline Refinances which require no income on the application, there are no stated income FHA loans. Everything must be fully documented in relation to income.
Two-Year Income History
When applying for an FHA loan, the borrower must provide the following:
- Two-year income and employment history with an explanation of gaps between jobs that span more than a 30-day period.
- A self-employed borrower must provide full tax return information from the last two years.
- A salaried borrower must provide the W-2s from the last two years.
- Current pay stub (or stubs) collected within the last 30 days, showing a full 30-day work history and indicating the total earnings year to date.
To verify the accuracy of what the borrower reported, the underwriter will compare the total year-to-date income from the pay stubs with the information listed on the loan application. If a discrepancy is found, the underwriter will make the assumption that the information on the loan application was inaccurate. Pay stubs and W-2s should be checked against the loan application to confirm that the monthly income has been reported accurately.
The underwriter will also assess the stability of the borrower's income. Employment issues within the last two years, including frequent job changes and moving from industry to industry, indicates a high risk factor. It is not uncommon for FHA to approve loans for borrowers who change jobs three to five times in a two-year period as long as they stay within the same line of work and are progressing in their career. However, frequent job changes generally indicate an unstable income.
Two-Year History of Variable Income
It is important to be diligent in documenting inconsistent wages or salary earnings. Income from commissioned, self-employed, or second-job income sources are highly volatile streams of income and are considered professions that fall into this category.
To be eligible for an FHA loan, it is necessary to document a consistent history of this type of income. Calculate this type of income using an average of the monthly total income for the previous two years. For instance, if a borrower has been working a second job for two years, take a two-year average based on actual W-2 earnings figures for that job. Then divide by 24 months to arrive at the accurate monthly income from that second job source. If a second job has been held for less than two years, the likelihood of its continuance is not considered high by FHA guidelines, and it cannot be used.
Two-Year Tax Returns for Self-Employed Borrowers
For borrowers who are receiving more than 25% of their income from either self-employment or commissioned work, tax returns must be provided, and the borrower's income will have to be documented based on the net income after all expenses. Extract the totals from the net proceeds section of the previous two-years' Schedule Cs and calculate the monthly average. A person who has been self-employed between 1 and 2 years is acceptable if they have been employed in the same line of work for 2 years (or 1 year of training, plus the year of employment).
Debt to Income Ratios
When all usable income sources have been totaled, it is important to consider the ratio concerns relative to FHA-approved loans. FHA loans using a manual underwriting process (not an automated underwriting system) are going to be limited to a 31/43 ratio. In other words, the "top" or "front" ratio of 31% of the borrower's income can be used for the proposed house payment, which includes homeowner?s insurance premiums, mortgage insurance premiums and estimated property taxes that will be due on the home. The "bottom" or "back-end" ratio (43%) can be used for the proposed new housing payment plus all other debt. The 31/43 ratios have a little bit of latitude, but not much on a manually underwritten FHA loan.
There are exceptions, including an "energy-efficient" mortgage. If the borrower is buying an energy-efficient home or improving an older home to a higher standard of energy efficiency, this would allow you to add two percentage points to the standard qualifying ratios. Such circumstances could raise the ratios to 33/45. Underwriters may give a little more flexibility if the borrower has an extremely strong credit profile, asset and income positions. But they generally will not be able to go much higher than a 31% or 32% front end ratio. Using an automated underwriting system will allow the borrower to qualify for a higher ratio. If the borrower has a clean credit history and decent assets, it is not uncommon to see loans with back end much higher get approved with an automated underwriting system. | 
