Non-Taxable Income for FHA Loans: Do 401(k) contributions count?

Question

It is my understanding that in calculating effective income for an FHA loan, non-taxable income (like child support for instance) may be grossed up at the greater of 15% or the borrower's tax rate for the previous year.

Do 401(k) contributions count as non-taxable income since the borrower received the economic benefit but did not pay tax on it since it was deducted from his/her paycheck?

Albert Bui · Answer

25% grossed for conventional and VA is still the same however FHA fluctuations depending locality. I have not come across non taxable income this year yet so it may have changed. Its very rare anyone even has non taxable income. Most of the time its a government employee who receives BAH - housing alloance, or BAS - food / living allowance.

401k contributions count as a loss if its employer related contribution and can still be used as income if its employer contributed. we use written verification of income (WVOE) to very income or you can use W2 but thats only one of the income documents WVOE is used with the most weight.

Sometimes the borrower is both the employer and the employee (S corporation or self employed).

Albert Bui · Answer

Buying a fourplex is great and all with FHA but its almost impossible in LA county unless you got a really good deal or in a really rough area.

After FHA changed their self sufficiency requirement from 100% of gross income to 75% of gross income - PITIA must be equal to or greater than 0 it made it much harder to qualify.

3 months reserves is also required - PITIA (prin/int/tax/ins/assesments).

In general you'll need a rent to price ratio of approximately .90% per month gross income to sales price or greater to make sure the fourplex qualifies for FHA.

Example: 750k fourplex X .90% = $ 6750 per month in gross income / 4 units = $ 1687.50 or greater rents per unit gross per month.

750k with 3.5% down = $ 723,750 @3.625% = $3,300.67 + 512.66 FHA MI + 781.25 prop tax + $135 insurance monthly = $ 4729.58 PITIA

75% of the 6750 = $5062.50 so this is still greater than 4729.58 so this property barely qualifes.

The problem is that its very hard to get a .90% rent to value ratio in LA or OC counties right now. Maybe if you cross into san bernardino or riverside or even Kern county as you mentioned you might be able to make it work with FHA but then your occupancy may be in question because you're working too far from your employment (unless if you telecommute).

Albert Bui · Answer

Yeah I've heard and seen guidelines as well then again guidelines and actual practice is where reality(rubber) meets the road.

I've done 2-3 duplexes in Santa Ana, CA and we used 25%. Could we have or should we have used 15% like HUD guidelines say? Probably? This the difference between guidelines and actual bank overlays some will bend to your argument if you keep reciting the 4155 booklet and some will go with their in house overlays. Its like the above post HUD dictates the "minimum," but banks go over and beyond (overlays) as well.

In my case we qualified either way because the borrowers had strong incomes and credit in addition to the 75% of the gross income (added to borrowers monthly qualifying income).

Its important to note that the above income use of 15-25% vacancy/operating expense factor is to calcualte income for DTI purposes not the self sufficiency rule which is 25% and is for a completely different purpose to meet the SS guideline.

Albert Bui · Answer

401k contributions have no effect and can be used if its employee contributed, its not a big deal its in effect money you made but you chose to contribute it to your 401k so you had the "choice," or access to it prior to the contribution thats why its counted. Employer contributed portion is considered a reduction of income or a cost to the business to retain talent or employee's so its considered a "cost," whether its on a schedule C for a sole proprietor or if its deducted on an 1120S or 1120 corporate tax return.

I just did a fourplex with FHA in March and it was 25% vacancy factor to determine SS rule prior I did one and it was 100% of gross income (some banks may have arbitrarily used 15% for risk reduction but it was 100% of gross income). Some banks have overlays that are over the normal required from FHa so it gets confusing sometimes talking about it online like this blog. As long as the lender achieves the min we could in effect require even more than the 25% discount if we were bearish on FHA fourplexes not performing well on our portfolio (if we're servicing the mortgages or just selling it off, etc).

Albert Bui · Answer

non taxable income can be grossed up 125% actually and 401k contributions or deductions count as regular income not "non taxable," income.

Non taxable income soures are usually military or government pay, child support received, long term disability sometimes is non taxable, tax exempt bonds/municipal bonds, etc.

Logan Allec · Answer

Hi @Albert Bui, that is interesting.  It was my understanding that previously, based on this document (that was superseded in September), net rental income for purpose of the self-sufficiency test was reduced by the greater of the appraiser's estimate for vacancies or the vacancy factor used by the jurisdictional Homeownership Center, which in California is 15% since California is covered by the Santa Ana Homeownership Center.

Logan Allec · Answer

Hi @Albert Bui

Thank you for this.  I was not aware that the FHA non-taxable gross up varies locally.  If you do come across a source for this (and happen to remember this conversation), please let me know!

Thank you for the clarification regarding 401(k) contributions.  Could you confirm that your intention was to state that "401(k) contributions...can still be used as income if they are employee-contributed"?

With respect to the self-sufficiency rule, didn't FHA previously use a vacancy factor of 15% (varied based on state, but in California it was 15%) and simply increased it to 25% with the new guidelines?

For what it's worth, last year I was able to acquire a fourplex in Los Angeles County (albeit in a rural area) using FHA financing, and I just want to make sure that I understand all the nuances of the new FHA guidelines.

Logan Allec · Answer

Hi @Albert Bui,

Thank you for your response.  I was under the impression that under the changes effective last September, the gross-up under the FHA guidelines was reduced to 15% under the new FHA Single Family Housing Policy Handbook (excerpt below).  Is my understanding not correct?  If so, could you provide a citation for the 25%?

Also, with respect to 401(k) contributions--do you get these from the W-2 and add them back to the number on the tax return?

Thanks!

Non-Taxable Income for FHA Loans: Do 401(k) contributions count?

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