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Calculating Income and Pay Stub Debt
Misrepresenting the customer’s income and overlooking non-standard pay stub debt may cause your car deal to be held up in funding. Often subprime lenders will charge additional fees to fund these deals, other times they will reject the car deal and return the contract unfunded to the dealership.
You want to optimize the income, but I recommended that you are a little conservative in this area. When in doubt concerning income, fax the documentation to the special finance lender and walk through the calculations together.
Types of Income
There are three primary types of income, employment income, self employment income, and fixed income.
The most common type of income is W2 Employment income. From April through December a single computer generated pay stub will suffice for POI. From January through March, you should require a current pay stub and the previous years W2 form
If the applicant does not have their W2, which is often the case in January, get their last pay stub for the previous year. This sub should have the same Year to Date information as the W2.
If the customer receives hand written pay stubs additional documentation is required. Obtain four consecutive pay stubs and a previous year W-2. In addition, some lenders may require a letter of employment, bank statements from the consumer and cancelled checks from the employer. If your applicant has hand written pay stubs and cashes their check at the local party store instead of depositing them into their bank account you may not have a deal with a few lenders.
Bad Credit and Self Employment is a tough combination. Most of the time self employed applicants do not have the required documentation to satisfy the special finance lenders POI requirement or they claim too many deductions to qualify; most lenders require 2 years tax returns. The tax returns also have to be prepared by a professional agency. With self employed applicants always send the POI to the lender before you put the car on the road.
In general fixed income is easy enough to prove. You’ll need a document that defines the entitlement, such as a court order for child support or an award letter for social security and proof that the entitlement is actually being received.
Verifying Income
With today’s technology just about anyone with a computer can fabricate or alter a pay stub. To minimize the risk of receiving bogus documents always insist the customer bring original pay stubs.
In addition to insisting on original pay stubs there is a simple calculation that you can perform to expose most pay stub fabrications. If your applicant makes less than $102,000 annually, the Social Security tax rate is 6.20%, and the Medicare tax rate is 1.45%. These items may be combined on the pay stub and displayed as FICA tax, when this is the case the tax rate is 7.65%
To performing this calculation subtract pre tax deductions such as medical insurance and 401K from the year to date income then multiply the result by appropriate percentage. The year to date deduction for that item should be close to your calculation.
For example, the Year to Date Income on a pay stub is 2617.94, there are no pre-tax deductions so the Social Security deduction should be close to the Year to date income times 6.2%, which is 162.31.
In the next example, the Year to Date Income is 9557.01, Social Security and Medicare deductions are combined so the FICA tax should be the year to date amount times 7.65 percent or 731.11.
In the last example, the year to date is 9058.44, there is a pre-tax benefit deduction of 315.68 and Social Security is listed separately. The social security deduction should be close to 9058.44 minus 315.68 times 6.2%, which is 542.05.
Calculating Income
Once you are satisfied that you have a genuine pay stub its time to calculate the applicants income. I always calculate income two ways, base pay calculated with the hourly wage or salary, and average income based on the year to date or W2 amount.
If the Base Pay calculation is greater than the Year to Date calculation or the W-2 income, further investigation is warranted. You will need to find out why the Year to Date Income is low; has the customer been working at their job as long as they had stated, did the customer have any substantial time off, or did they receive a pay raise during the year?
If the Year to Date calculation or the W-2 income is greater than the Base Pay calculation then the applicant earns overtime income.
Each lender has different requirements for counting and calculating overtime income. Some lenders may require only three month Year to Date totals, where as other lenders may require four or more.
To calculate base monthly pay multiply the hourly wage times 40 and that result time 4.33. 4.33 is the average number of weeks in a month. You would get the same result if you multiply the weekly income by 52 weeks and divide by twelve months.
Let’s say you have a pay stub with a period ending of 12/08/09, the YTD income is 27,797.47, and the hourly wage is 14.00 per hour; to calculate the monthly base pay multiply 14 dollars per hour by 40 hours in a week and then by 4.33 weeks in a month. The result is $2424.80.
MONTHLY BASE PAY = (HOURLY WAGE) X (40 HOURS) X (4.33 WEEKS)
To calculate the monthly base pay based from the year to date income, first calculate the portion of the year that the ending date represents. In our case the period ending was 12/8/07. Another way to think about this is 11 full months plus 8 days, since there are 31 days in December 8 days represents roughly 26% of a month, so the year to date figures are for 11.26 months. Simply, divide the Year to Date income by the 11.26 months. The average monthly income is $2,468.69.
To ensure your car deal funds quickly without additional fees accessed by the subprime lender, always insist on original documentation, especially if the information was received via fax and get in the habit of calculating income and verifying the FICA math on every deal.
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