What is the FHA "Deficit Income Test"?

Effective October 1, 2013, the new FHA PFS guidelines (FHA Mortgagee Letter 2013-23) separate borrowers into two categories:  Streamlined & Standard.   

Borrowers applying through the “Streamlined” short sale program must be more than 90 days delinquent and meet additional criteria but do not have to submit financial documentation and do not have to prove hardship.

The other category, however, “Standard” short sale borrowers must provide financial information and pass the Deficit Income Test.  

So what is this Deficit Income Test?

According to Mortgagee Letter 13-23 , the Deficit Income Test “ …is calculated by subtracting total monthly expenses from total monthly net income. The DIT issued to determine if a mortgagor can sustain his/her mortgage or if a mortgagor is experiencing a hardship that may qualify the mortgagor for a standard PFS. A DIT yielding a negative amount would indicate that the mortgagor’s expenses exceed his/her income each month and, thus a PFS may be an appropriate loss mitigation tool for the mortgagor if a loss mitigation home retention option is not viable.”

Sounds very similar to the previous Financial Analysis, doesn’t it?  Almost.

The difference is in the documentation required to support the borrower’s financial situation.  The rules are a little stricter.

Verifying income:

Documents required verifying income is pretty much the same:  recent paystubs, Profit & Loss Statements, Social Security or Disability Income, and a Federal Tax Return (or W2, 1099).

Verifying expenses:

According to ML 13-23, the servicer must “…verify the mortgagor’s monthly expenses by ensuring that all expenses on the mortgagor’s credit report are factored into the DIT along with any other expenses that are supported by bills, payment receipts, and/or the standard payment amounts (e.g., for utilities) under an IRS Index (such as the IRS Collection Financial Standards).”   

Explanations of the five categories are pasted below and are also found at www.IRS.gov :

“Food includes food at home and food away from home. Food at home refers to the total expenditures for food from grocery stores or other food stores. It excludes the purchase of nonfood items. Food away from home includes all meals and snacks, including tips, at fast-food, take-out, delivery and full-service restaurants, etc.

Housekeeping supplies includes laundry and cleaning supplies, stationery supplies, postage, delivery services, miscellaneous household products, and lawn and garden supplies.

Apparel and services includes clothing, footwear, material, patterns and notions for making clothes, alterations and repairs, clothing rental, clothing storage, dry cleaning and sent-out laundry, watches, jewelry and repairs to watches and jewelry.

Personal care products and services includes products for the hair, oral hygiene products, shaving needs, cosmetics and bath products, electric personal care appliances, and other personal care products.

The miscellaneous allowance is for expenses taxpayers may incur that are not included in any other allowable living expense items, or for any portion of expenses that exceed the Collection Financial Standards and are not allowed under a deviation.  Taxpayers can use the miscellaneous allowance to pay for expenses that exceed the standards, or for other expenses such as credit card payments, bank fees and charges, reading material and school supplies.

Taxpayers are allowed the total National Standards amount monthly for their family size, without questioning the amounts they actually spend. If the amount claimed is more than the total allowed by the National Standards for food, housekeeping supplies, apparel and services, and personal care products and services, the taxpayer must provide documentation to substantiate those expenses are necessary living expenses. Deviations from the standard amount are not allowed for miscellaneous expenses. Generally, the total number of persons allowed for National Standards should be the same as those allowed as exemptions on the taxpayer’s most recent year income tax return.”

The Bottom Line:

It's wonderful that, according to some experts, the housing industry is in recovery but there remains thousands & thousands of homeowners underwater and facing financial crisis.

When submitting docs for a standard FHA pre-foreclosure sale (short sale), be prepared to include an explanation along with receipts for any amounts exceeding the IRS Collection Financial Standards.

Let us know how we can help.