During the second quarter of 2021, the Federal Reserve Bank of St. Louis reported that the delinquency rate on mortgages for a single-family home was 2.49%. This is not a large number, but for mortgage lenders, the amount at stake is high as homeowners typically pay hundreds of thousands of dollars for a house or condo. Knowing the borrower can pay back the mortgage is critical.
Millennials make up the largest share of home buyers at 37% and they are also disproportionally first-time homebuyers. For younger millennials ages 21 to 28, 86% are first time homebuyers and for older millennials ages 29 to 38, 52% are first time home buyers. Lenders need an employment verification process to be sure these borrowers, and all others, have the income to pay back a mortgage that will likely be their largest monthly bill.
A main way to do this is through employment verification, which is a typical mortgage requirement. Employment verification involves paperwork including paystubs, tax returns, W2s and alternative forms of verification such as a written Verification of Employment (VOE) to assess a borrower’s employment history.
Employers are not required to fill out written VOE forms from mortgage lenders as part of the employment verification process, but most do so as it benefits employees. Employers may require written consent from employees before providing written verification.
Income Verification Process
The home buying process includes many steps, but the main one is mortgage underwriting where the lender assesses a borrower’s ability to pay. The initial assessment is automated and reviewed based on documents submitted. It aims to verify specific details and looks at three main areas:
- Credit: Your credit score reflects any foreclosures or bankruptcies, the status of revolving loans and any unpaid bills.
- Capacity: Capacity focuses on your debt-to-income ratio (DTI), which is discussed below in detail and shows if you have a manageable level of debt.
- Collateral: Collateral examines your down payment amount and the property you are looking to buy to see what risk you pose of defaulting.
Central to all of these assessments is your employment history for the preceding two years. For salaried borrowers, this employment verification is completed through pay stubs, tax returns and W2s. For self-employed borrowers, the list is longer and includes tax returns and 1099 forms along with profit and loss statements. These lender requests are typical mortgage requirements, along with bank statements.
This process to verify income is initially completed by computers and uses automated underwriting systems. It often raises red flags or areas needing more information. At this point, manual underwriters take over to analyze the information and request additional income verification documents.
Written Verification of Employment (VOE) Explained
When W2 income information for salaried employees provided by W2s is not enough, lenders will request a written VOE as part of the employment verification process. Unlike W2s, pay stubs and tax forms, this must be completed by a current or previous employer.
The written VOE, or Fannie Mae VOE Form 1005, includes information about date of hire, termination date (if applicable), compensation and compensation structure (bonuses, commissions). It might also include information about the probability of continued employment if employment status is a concern, date and amount of next pay increase, and reasons for leaving. If this additional information is provided, it must be considered as part of the income and employment analysis.
The document must be computer generated or typed by the borrower’s employer. It can be filled out by the HR department, personnel office, payroll department, outside payroll vendor, or a borrower’s current or former supervisor. Self-employed borrowers do not use a written VOE and instead provide tax documents to verify income.
Why is Income Verification Important?
Borrowers’ income is used to calculate the debt-to-income ratio (DTI), which compares how much you owe each month to how much you spend. This ratio gives lenders an indication of how likely you are to be able to pay your mortgage each month regardless of unexpected expenses. There are two different DTIs:
- Front-end ratio (Housing Ratio): Calculates how much of your gross income is spent on housing costs including your mortgage. Equation: housing expenses/gross monthly income. Lenders usually prefer a ratio of 28% or lower.
- Back-end ratio: Calculates how much of your gross monthly income goes toward paying all debts including a mortgage and non-housing debt. Equation: total monthly expenses/gross monthly income. Lenders usually prefer a ratio of 36% or lower.
Income and employment history, along with credit scores, gives lenders a full picture of a borrower’s ability to repay a mortgage loan. Written verification of income (VOE), when included in the employment verification process, helps lenders be certain a borrower can repay a mortgage. To learn more about all aspects of the home buying process, visit the Own Up blog.