The Federal Housing Administration, an agency within the Department of Housing and Urban Development, insures mortgages made by approved lenders. Although often associated with with low- and moderate-income borrowers, due to its flexible income qualifying guidelines the FHA does not have income limits. FHA underwriting bases the maximum amount borrowers qualify for on verifiable and stable employment and income. Overtime income may also be calculated if it meets this criteria.
According to FHA, effective income is verifiable, stable and likely to continue through the first three years of the loan. Generally, it is limited to salary and wages; however, overtime income may be used to qualify if the overtime has been received for the past two years and can be documented with income tax returns or a tax transcript obtained directly from the Internal Revenue Service. Overtime income can be used to qualify borrowers, co-borrowers and co-signers.
Underwriting must establish that overtime availability is likely to continue if used to calculate the borrower's income. The lender must obtain a verification of employment directly from the employer, which states that overtime is either likely or unlikely to continue for the borrower.
The lender must calculate the average amount of overtime earning for the past two years. Borrowers with less than two years' worth of overtime may qualify using the income at the underwriter's discretion. In such cases, the underwriter must justify in writing the reason for including the overtime in their calculation.
The underwriter must establish an overtime earning trend. If overtime income is on a continual decline, he must justify in writing his reason for including it for qualifying purposes. A trend that shows the overtime income varies significantly from year to year must be calculated using an average of more than two years.
A positive trend in the borrower's overtime earning may be used as a compensating factor. Compensating factors help underwriters justify loan approval in the event a borrower falls short in another area of qualifying; for instance, if they have low credit or high debt-to-income ratios.
FHA-approved lenders vary, as do their underwriters. Although FHA underwriting guidelines are relatively flexible, not all underwriters will agree on using less than two years' worth of overtime income to qualify for a higher loan amount, especially if debt-to-income ratios are on the high end of FHA's benchmark ratios; that is, above 31 percent for the mortgage-to-payment ratio and 43 percent for the total debt-to-income ratio. A lender that does allow for less than two years may require the average overtime income to be calculated over a full 24 months, rather than the actual amount of months worked.