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The lender must verify that sufficient funds to cover the gift are either in the donor’s account or have been transferred to the borrower’s account. Acceptable documentation includes the following:

• a copy of the donor’s check and the borrower’s deposit slip,
• a copy of the donor’s withdrawal slip and the borrower’s deposit slip,
• a copy of the donor’s check to the closing agent, or
• a settlement statement showing receipt of the donor’s check.

When the funds are not transferred prior to settlement, the lender must document that the donor gave the closing agent the gift funds in the form of a certified check, a cashier’s check, or other official check.

For more information, see B3-4.3-04, Personal Gifts.

Gifts must be evidenced by a letter signed by the donor, called a gift letter. The gift letter must:

• specify the dollar amount of the gift;
• specify the date the funds were transferred;
• include the donor’s statement that no repayment is expected; and
• indicate the donor’s name, address, telephone number, and relationship to the borrower.

When a gift from a relative or domestic partner is being pooled with the borrower’s funds to make up the required minimum cash down payment, the following items must also be included:

• A certification from the donor stating that he or she has lived with the borrower for the past 12 months and will continue to do so in the new residence.
• Documents that demonstrate a history of borrower and donor shared residency. The donor’s address must be the same as the borrower’s address. Examples include but are not limited to a copy of a driver’s license, a bill, or a bank statement.

For additional information, see B3-4.3-04, Personal Gifts.

A borrower of a mortgage loan secured by a principal residence or second home may use funds received as a personal gift from an acceptable donor.  Gift funds may fund all or part of the down payment, closing costs, or financial reserves subject to the minimum borrower contribution requirements.  Gifts are not allowed on an investment property.

For additional information, see B3-4.3-04, Personal Gifts.  

Variable Income
All income that is calculated by an averaging method must be reviewed to assess the borrower’s history of receipt, the frequency of payment, and the trending of the amount of income being received. Examples of income of this type include income from hourly workers with fluctuating hours, or income that includes commissions, bonuses, or overtime. 

History of Receipt: Two or more years of receipt of a particular type of variable income is recommended; however, variable income that has been received for 12 to 24 months may be considered as acceptable income, as long as the borrower’s loan application demonstrates that there are positive factors that reasonably offset the shorter income history. 

Frequency of Payment: The lender must determine the frequency of the payment (weekly, biweekly, monthly, quarterly, or annually) to arrive at an accurate calculation of the monthly income to be used in the trending analysis (see below). Examples: 

• If a borrower is paid an annual bonus on March 31 st of each year, the amount of the March bonus should be divided by 12 to obtain an accurate calculation of the current monthly bonus amount. Note that dividing the bonus received on March 31st by three months produces a much higher, inaccurate monthly average. 
• If a borrower is paid overtime on a biweekly basis, the most recent paystub must be analyzed to determine that both the current overtime earnings for the period and the year-to-date overtime earnings are consistent and, if not, why. There are legitimate reasons why these amounts may be inconsistent yet still eligible for use as qualifying income. For example, borrowers may have overtime income that is cyclical (transportation employees who operate snow plows in winter, package delivery service workers who work longer hours through the holidays). The lender must investigate the difference between current period overtime and year-to-date earnings and document the analysis before using the income amount in the trending analysis. 

Income Trending: After the monthly year-to-date income amount is calculated, it must be compared to prior years’ earnings using the borrower’s W-2’s or signed federal income tax returns (or a standard Verification of Employment completed by the employer or third-party employment verification vendor). 

• If the trend in the amount of income is stable or increasing, the income amount should be averaged. 
• If the trend was declining, but has since stabilized and there is no reason to believe that the borrower will not continue to be employed at the current level, the current, lower amount of variable income must be used. 
• If the trend is declining, the income may not be stable. Additional analysis must be conducted to determine if any variable income should be used, but in no instance may it be averaged over the period when the declination occurred. 

For additional information, see B3-3.1-01, General Income Information.

The lender must obtain copies of the borrower’s signed federal income tax returns filed with the IRS for the past two years for borrowers who are employed by family.

Additionally, income documentation requirements outlined in B3-3.1-03, Base Pay (Salary or Hourly), Bonus, and Overtime Income or per the Desktop Underwriter (DU) findings report must be met.

Note: If a borrower’s income is validated by the DU validation service, lenders are not required to determine if the borrower is employed by a family member or interested party to the property sale or purchase. See B3-2-02, DU Validation Service for additional information.

For more information, see B3-3.1-01, General Income Information. 

A year-to-date profit and loss statement is not required for most businesses, but if the borrower’s loan application is dated more than 120 days after the end of the business’s tax year, the lender may choose to require this document if it believes that it is needed to support its determination of the stability or continuance of the borrower’s income.

For additional information, see B3-3.4-04, Analyzing Profit and Loss Statements.

Sole Proprietorship,Schedule C

Non-recurring income must be deducted in the cash flow analysis, including any exclusion for meals and entertainment expenses reported by the borrower on Schedule C.

The following recurring items claimed by the borrower on Schedule C must be added back to the cash flow analysis: depreciation, depletion, business use of a home, amortization, and casualty losses.

For additional information, see B3-3.3-03, Income or Loss Reported on IRS Form 1040, Schedule C and Fannie Mae’s Cash Flow Analysis (Form 1084)*.

*For a complete list of forms used in fulfilling requirements contained in the Selling and Servicing Guides, see the Guide Forms page.

Partnership, LLC, or S Corporation

Items that can be added back to the business cash flow include depreciation, depletion, amortization, casualty losses, and other losses that are not consistent and recurring.

The following items should be subtracted from the business cash flow for a Partnership, LLC or S Corporation:

• travel and meals exclusion,
• other reported income that is not consistent and recurring, and
• the total amount of obligations on mortgages, notes, or bonds that are payable in less than one year. These adjustments are not required for lines of credit or if there is evidence that these obligations roll over regularly and/or the business has sufficient liquid assets to cover them.

For additional information, see B3-3.4-01, Analyzing Partnership Returns for a Partnership or LLC and B3-3.4-02, Analyzing Returns for an S Corporation.

Corporation

Items that can be added back to the business cash flow include depreciation, depletion, amortization, casualty losses, net operating losses, and other special deductions that are not consistent and recurring.

The following items should be subtracted from the business cash flow for a Corporation:

•  travel and meals exclusion,
•  tax liability and amount of any dividends, and
•  the total amount of obligations on mortgages, notes, or bonds that are payable in less than one year. These adjustments are not required if there is evidence that these obligations roll over regularly and/or the business has sufficient liquid assets to cover them.

For additional information, see B3-3.4-03, Analyzing Returns for a Corporation.

The lender may use discretion in selecting the method to confirm that the business has adequate liquidity to support the withdrawal of earnings. When business tax returns are provided, for example, the lender may calculate a ratio using a generally accepted formula that measures business liquidity by deriving the proportion of current assets available to meet current liabilities. 

It is important that the lender select a business liquidity formula based on how the business operates. For example: 

• The Quick Ratio (also known as the Acid Test Ratio) is appropriate for businesses that rely heavily on inventory to generate income. This test excludes inventory from current assets in calculating the proportion of current assets available to meet current liabilities.  Quick Ratio = (current assets — inventory) ÷ current liabilities 
• The Current Ratio (also known as the Working Capital Ratio) may be more appropriate for businesses not relying on inventory to generate income. Current Ratio = current assets ÷ current liabilities

For either ratio, a result of one or greater is generally sufficient to confirm adequate business liquidity to support the withdrawal of earnings. 

For additional information, see: 

• B3-3.4-01, Analyzing Partnership Returns for a Partnership or LLC 
• B3-3.4-02, Analyzing Returns for an S Corporation

Income or Loss Reported on IRS Form 1065 or IRS Form 1120S, Schedule K-1

The version of Schedule K-1 that is utilized to report a borrower’s share of income (or loss) is based on how the business reports earnings for tax purposes:

• partnership — reported on IRS Form 1065, Schedule K-1;
• S corporation — reported on IRS Form 1120S, Schedule K-1; and
• LLC — reported on either IRS Form 1065 or IRS Form 1120S, Schedule K-1, depending on how the federal income tax returns are filed for the LLC.

The lender must use caution when including income that the borrower draws from the borrower’s partnership or S corporation as qualifying income. Ordinary income, net rental real estate income, and other net rental income reported on Schedule K-1 may be included in the borrower’s cash flow provided the lender can confirm that the business has adequate liquidity to support the withdrawal of earnings, as described below:

• If the borrower has a two-year history of receiving “guaranteed payments to the partner” from a partnership or an LLC, these payments can be added to the borrower’s cash flow.
• If the Schedule K-1 reflects a documented, stable history of receiving cash distributions of income from the business consistent with the level of business income being used to qualify, then no further documentation of access to the income or adequate business liquidity is required. But if the Schedule K-1 does not reflect a documented, stable history, then the lender must confirm adequate business liquidity.

If business tax returns are required, then the lender must consider the type of business structure and analyze the business returns, according to the requirements described in B3-3.2-01, Underwriting Factors and Documentation for a Self-Employed Borrower.

See also, B3-3.3-07, Income or Loss Reported on IRS Form 1065 or IRS Form 1120S, Schedule K-1.

Limited Cash-Out Refinance Transactions.  The continuity of obligation policy that required lenders to confirm at least one of the borrowers on a refinance transaction was also a borrower on the prior mortgage, specified a minimum number of months a borrower needed to be on title, and indicated LTV, CLTV, HCLTV ratio restrictions for limited eligibility, was eliminated in its entirety as of February 2016. 

Note: A short-term refinance mortgage loan that combines a first mortgage and a non-purchase-money subordinate mortgage into a new first mortgage or any refinance of that loan within six months is ineligible as a limited cash-out refinance and must be treated as a cash-out refinance.

Refer to Selling Guide Announcement SEL-2016-02 and B2-1.2-02, Limited Cash-Out Refinance Transactions for additional information.

Cash-Out Refinance Transactions.  For cash-out refinance transactions, the property must have been purchased (or acquired) by the borrower at least six months prior to the disbursement date of the new mortgage loan except for the following:

• There is no waiting period if the lender documents that the borrower acquired the property through an inheritance or was legally awarded the property (divorce, separation, or dissolution of a domestic partnership).

• The delayed financing requirements are met. 

• If the property was owned prior to closing by a limited liability corporation (LLC) that is majority-owned or controlled by the borrower(s), the time it was held by the LLC may be counted towards meeting the borrower’s six month ownership requirement. (In order to close the refinance transaction, ownership must be transferred out of the LLC and into the name of the individual borrower(s). See B2-2-01, General Borrower Eligibility Requirements for additional details.

• If the property was owned prior to closing by an inter vivos revocable trust, the time held by the trust may be counted towards meeting the borrower’s six month ownership requirement if the borrower is the primary beneficiary of the trust.

Cash-out refinance transactions must meet the following requirements:

• The transaction must be used to pay off existing mortgages by obtaining a new first mortgage secured by the same property or by a new mortgage on a property that does not have a mortgage lien against it.
• Properties that were listed for sale must have been taken off the market on or before the disbursement date of the new mortgage loan.
• The property must have been purchased (or acquired) by the borrower at least six months prior to the disbursement date of the new mortgage loan except for the following:
  • There is no waiting period if the lender documents that the borrower acquired the property through an inheritance or was legally awarded the property (divorce, separation, or dissolution of a domestic partnership).
  • The delayed financing requirements are met. 
  • If the property was owned prior to closing by a limited liability corporation (LLC) that is majority-owned or controlled by the borrower(s), the time it was held by the LLC may be counted towards meeting the borrower’s six month ownership requirement. (In order to close the refinance transaction, ownership must be transferred out of the LLC and into the name of the individual borrower(s). See B2-2-01, General Borrower Eligibility Requirements for additional details.
  • If the property was owned prior to closing by an inter vivos revocable trust, the time held by the trust may be counted towards meeting the borrower’s six month ownership requirement if the borrower is the primary beneficiary of the trust.
  • For DU loan casefiles, if the DTI ratio exceeds 45%, six months reserves is required. 

For the maximum allowable LTV, CLTV, and HCLTV ratios and credit score requirements for cash-out refinances, see the Eligibility Matrix.  For additional information, see B2-1.2-03, Cash-Out Refinance Transactions.

Borrowers who purchased the subject property within the past six months (measured from the date on which the property was purchased to the disbursement date of the new mortgage loan) are eligible for a cash-out refinance if all of the following requirements are met. Refer to B2-1.2-03, Cash-Out Refinance Transactions for documentation and other requirements regarding cash-out refinance transactions.

For additional information, see B2-1.2-03, Cash-Out Refinance Transactions

Non-arm's length (NAL) transactions are purchase transactions in which there is a relationship or business affiliation between the seller and the buyer of the property. Fannie Mae allows non-arm’s length transactions for the purchase of existing properties unless specifically forbidden for the particular scenario, such as delayed financing.

For the purchase of newly constructed properties, if the borrower has a relationship or business affiliation (any ownership interest, or employment) with the builder, developer, or seller of the property, Fannie Mae will only purchase mortgage loans secured by a principal residence. Fannie Mae will not purchase mortgage loans on newly constructed homes secured by a second home or investment property if the borrower has a relationship or business affiliation with the builder, developer, or seller of the property. 

For additional information, see B2-1.2-01, Purchase Transactions.

Lenders must be in compliance with the Selling Guide regarding other parameters applicable to the subject loan, as well as, other guidelines pertaining to interested parties to the transaction, such as, but not limited to, interested party contributions (IPCs).

The requirements for second home properties are provided below: 

• must be occupied by the borrower for some portion of the year
• restricted to one-unit dwellings
• must be suitable for year-round occupancy
• the borrower must have exclusive control over the property
• must not be rental property or a timeshare arrangement*
• cannot be subject to any agreements that give a management firm control over the occupancy of the property

*If the lender identifies rental income from the property, the loan is eligible for delivery as a second home as long as the income is not used for qualifying purposes, and all other requirements for second homes are met (including the occupancy requirement above)

For maximum allowable LTV/CLTV/HCLTV ratios and representative credit score requirements for a second home, see the Eligibility Matrix. 

Additional guidance on entering housing expenses in DU for second home properties, see the related DU Job Aid.

An LLPA applies to certain loans secured by second homes. This LLPA is in addition to any other price adjustments that are otherwise applicable to the particular transaction. See the Loan-Level Price Adjustment (LLPA) Matrix.

For more information related to occupancy types, refer to B2-1-01, Occupancy Types.