Please ensure Javascript is enabled for purposes of website accessibility
Efficient Calculation of Variable Income for Fannie Mae

Efficient Calculation of Variable Income for Fannie Mae

Before Fannie Mae and Freddie Mac were created, mortgages were sold the way family heirlooms are passed down. Your local bank would make space on its balance sheet for you, and what would follow would be the relationship of a lifetime. While small-time banking ended up not being able to handle the sheer business volume of mortgages, leading to the expansion of bigger lenders into the mortgage market—the personal touch is one we all miss.

In today’s digital and transactional world, we’re used to seeing everything as a means to an end. But did you know that remnants of the personal past still live on today? Though you may not see them as often as your realtor, processors still add a human touch to all decisions regarding your mortgage application.

When a mortgage application, otherwise known as a 1003 lands on a processor’s desk, it’s not just the borrower’s history that qualifies them for a home. The way that the processor chooses to calculate income (of which there are a couple of options), can make all the difference when it comes to qualifying for a home versus having to walk away from the purchase of a lifetime.

The Four Cornerstones of Lending

The first thing a processor needs to think about when considering a borrower’s eligibility is to take into account the four Cs:

  • Credit
  • Capacity
  • Capital
  • Collateral


Lenders check your credit history using FICO’s loan model for mortgages (normally loan models 5, 4 & 2). This will look at your debt-to-income ratio. How many credit accounts do you have? This includes student loans, car loans, and any other currently revolving credit accounts. Together, your credit mix makes up 10% of your final score. Another 10% comes from how many new accounts you’ve opened in the past year, and another 15% depends on how many years you’ve been actively using credit. Approximately 30% of your credit score depends on the amount of debt you currently have on hand, and another 35% depends on how often you make timely payments on your debts.


A borrower’s capacity refers to how capable they are of paying back their mortgage. This takes into account current and past employment (previous 24 months required), as well as how likely their current income will continue.

For example, someone who works a full time job but works crazy amounts of overtime, may not be taken as seriously by an underwriter, because realistically, how sustainable is that work pace? While overtime pay does factor into debt-to-income calculations, it doesn’t mean that processors turn a blind a eye to the reality of a borrower's situation. Their job is to crunch numbers, sure, but with context and good judgment. Their job is to make sound investment decisions for the lender willing to issue a borrower a home loan.

In this sense, that makes processors the first line of defense when it comes to maintaining housing liquidity and accessibility. The little wiggle room that’s given to processors based on the good faith of their judgment, means that they have a lot of power and responsibility when weighing the pros and cons of a borrower’s file.

If the mortgage world were a royal court, then underwriters would be the king’s advisors. That would make processors the king’s knights, quietly following the code of chivalry, but also being brave enough to push back and even requesting to duel on behalf of their borrower if needed.


A borrower’s capital refers to their cash reserves. Savings, stocks, mutual funds, IRAs, 401Ks, and certificates of deposit all act as capital. They show that you know how to manage your funds, as well as your income, and that you have cash reserves to pay your debts in the case of an unforeseen event.

Money gifts from family and money from grants or government programs also qualify as capital.


Lastly, collateral refers to what you’re willing to put on the line if for some reason you can no longer afford to make payments on your home. In the case of a mortgage, the home itself is the collateral, as a borrower can lose it if they can no longer afford to make payments and the home goes into foreclosure.

Calculating Income 101

First things first, a processor will look at your capacity to pay a mortgage back. They’ll ask for what type of income (if it’s fixed or variable), as well as two years of pay stubs besides the current year’s income.

Once a processor sees that your employment and income are consistent, they’ll get down to analyzing it based on whether your income is fixed or variable. Types of fixed and variable income include:

Fixed Income

  • Salary/Base Pay
  • Pension
  • Social Security
  • Child Support
  • Alimony
  • Notes Receivable

Variable Income

  • Commission
  • Bonus
  • Self-employed
  • Seasonal
  • Hourly
  • Contract
  • Tips
  • Overtime

Income Documentation Needed

A processor will need the following to process your loan:

  • Pay stubs
  • W-2s from the past two years
  • Written Verification of Employment (VOE)
  • Personal tax returns
  • 3rd party verification providers such as a work phone number
  • Processing guidelines to check for document acceptability

Processors need to have their loan guidelines ready (these can vary depending on the lender you’re working with) so that they can check for red flags from the get-go.

Income Processing Tips

  • Handwritten documentation will not be accepted.
  • Pay stubs should be dated no later than 30 days from the start of the application date.
  • Pay stubs should include all year-to-date earnings.
  • 3rd party verification providers, such as work numbers, have a shortened expiration time (only valid for 35 days). Once the 35 days are over, database information becomes stale.
  • Most other documentation (minus 3rd party verification) is good for 120 days.
  • If a borrower submits a W-2, then an IRS transcript will be needed.
  • Make sure that all pay stub information matches that on the 1003 application.
  • Make sure that taxes are being withdrawn (pay stubs don’t always mention it). If the borrower is a 1099 contractor, you’ll need a different form.
  • When calculating income, always round up or down to the nearest dollar.
  • If a W-2 has a 401K, remember that this is considered an asset. If a 401K is used as an asset, then it'll be deducted from the loan balance of the asset. Or it'll be deducted from the borrower's income. This won’t be added to the liability section or debt because it’s part of a borrower’s capital.

Processing Different Types of Income

The types of income calculation covered in today’s post will be:

  • Base or Salary Pay
  • Commission
  • Bonuses
  • Hourly Wages
  • Overtime

Formulas for Calculating Monthly Income


hours per week x hourly rate x 52 weeks

_________________________________ = monthly income


Bi-weekly (paid every other week)

base pay x 26 weeks

_________________ = monthly income


Bi-monthly (paid twice a month)

base pay x 24 weeks

_________________ = monthly income


Calculating Bi-weekly Base Pay

When it comes to calculating bi-weekly base pay, keep in mind that the borrower is being paid every other week, rather than twice a month. Because of that, those paid on a bi-weekly salary get two extra payments throughout the year versus those paid on a bi-monthly schedule.

Let’s start with an example:

Elizabeth’s pay stub indicates that she gets paid $2307.70 on a bi-weekly basis. We’ll round that up to $2308 for our calculations.

2308 x 26 weeks

_________________ = monthly income



_______ = 5,000.6666 = $5001


Then you’ll calculate the year-to-date income. Based on Elizabeth’s current pay stub, that’s $27,692 up until 6/14, which is the date of her most recent pay stub.

To get the year-to-date income, we’ll divide $27,692 by 5.47 months.


______ = $5,063


Then you’ll have to do the same year-to date income calculation for the past two years worth of W-2s. We’ll be using gross wages, which can be found in box 5 of your W-2.

For 2018, Elizabeth’s gross income was $57,400. Divided by 12, that means that Elizabeth made a gross monthly income of $4,783 in 2018.

For 2017, Elizabeth earned a gross income of $55,201. Divided by twelve months, that means Elizabeth had a gross income of $4,600 a month in 2017.

So your four calculations should look like this:

Now, it does show that Elizabeth is married, so now we’ll look at her husband Peter’s income, since he’s her co-borrower.

Calculating Bi-monthly Base Pay

Remember that the processor is supposed to use their good judgment when qualifying a borrower. A lot of times, that means being able to figure out why someone’s income yo-yos up and down over the years, among other things.

For example, Elizabeth’s husband just so happens to be a teacher. So before even calculating his income, the processor needs to find out if they’re a 10 month or 12 month employee, since not all teachers work during the summer. To verify the information, the processor might call the school and ask for a copy of the teacher’s contract from HR. Or the processor could double check the website of the county where Peter works to verify how many months he works out of a year.

Before we analyze Peter’s pay stub, keep in mind that income calculation is done by taking into account a period ending date for payment—not the pay stub date.

Based on the pay stub’s period ending, which was on 6/15, we can deduce that Peter is paid on a bi-monthly basis. His four income calculations should look like this:

Calculating Variable Income

While we’ve done the calculations for Elizabeth and Peter’s income, it turns out that Peter also works as a contractor for another company part-time.

Using the hourly wage calculation formula, here are his four income calculations:

When you’re calculating part-time income, you’ll need to average the two income calculations for most recent and prior year’s W-2s.

To get the 24 month average, just add $442 and $417 and divide by 2. You’ll get $429 as your average, though if you wanted to be more conservative, you could say $417. However, there’s no need to limit your borrower if you don’t have to, so go ahead and give them the $429 variable income average.

Calculating Overtime Income

The first rule of thumb when calculating overtime income is: is it consistent? If it’s not consistent, then it’ll be thrown out entirely, because it’s not a source of income that the lender can count on the borrower having regularly.

Above all else, the processor should look at the overall risk assessment of the file. If someone makes good money but works 70 to 80 hours a week, that overtime may not be worth its weight in gold, because how sustainable is it, really?

Below we have a completely separate borrower who works lots of overtime:

By looking at the year-to-date and past 24 month incomes, we can see that both base pay and overtime fluctuate, but let’s calculate it to make sure.

A processor has two choices once they see that overtime income is inconsistent. They can either get to the bottom of why there’s an income disparity or simply run with the lowest overtime income of $1,071 to try and qualify a borrower. A processor should never use the year-to-date average!

Another note too, is that even if the person applying for a home got a raise, it doesn’t mean that you don’t have to use a 24 month average. That only applies to base pay.

Calculating Overtime & Bonus Income

In this example, we’ll be analyzing overtime and bonuses for a delivery driver.

Already, we can see from the green box that the overtime income is inconsistent. When we calculate the income, this is what we get:

These numbers have huge gaps, but when a processor called to verify the numbers, they found out that the driver worked for UPS, and tended to get more overtime right near the end of the year during the holidays.

Then there was the issue of calculating the delivery driver’s bonus pay:

Looking at the driver’s bonus pay over the past three years, it was alarming to see that he hadn’t been paid a bonus that year.

But when a processor called to confirm, the driver’s employer stated that bonuses were paid near the end of the year—so it all checked out.

Calculating Commission Income

To qualify a borrower who works mainly on commission, you’ll first need two years of income history and a letter of verification of employment. A borrower can have less than two years of employment history if they have a valid reason, such as layoffs during the pandemic, etc. You’ll also need pay stubs and two years of W-2 forms.

Here are the gross earnings for a regional field representative:

And then their income calculation:

Now when it comes to commission, fluctuations in income aren’t rare. But the processor needs to find out why that’s happening. Did the borrower decide they wanted a higher base rate and less commission? The processor needs to get to the bottom of this, and then request a letter of explanation to include in the file.

A rule of thumb is that if the commission income fluctuation between years is greater than 10%, a processor should question the income consistency.

In some cases, a processor may need to throw out the year with the highest commission income for the average. And in cases where a borrower hasn’t been employed for 24 months, the processor will first need to to get their hands on at least 12 months of previous income. The income from a previous commission job can be used if the person hasn’t been employed for a full 24 months before applying for a home loan.

Differential Income

In terms of calculating differential income, such as nurses or factory workers, who get paid more when they take on shifts over the weekend or at night, you can take all of the income into account and average it.

A Spectrum of Decisions

At the end of the day, the processor has an ethical responsibility to calculate income accurately and to the borrower’s favor when there is some room for interpretation. It’s important to take stock of the situation and look over documents carefully. The point of processing isn’t to approve as many files as possible—it’s to make sure that you help as many future homeowners as you can.

There’s a lot of power in these small ways of being able to present a borrower’s file to an underwriter. While the underwriter gets the final say, the processor gets to set the scene, and they should be pulling out all the stops for your file: good lighting, an incredible backstory—the works.