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Variable Income Averaging (Overtime, Bonus, Commission)

Variable income averaging is the underwriting methodology lenders use to calculate a stable qualifying income figure from fluctuating earnings such as overtime, bonuses, and commissions, typically by averaging documented income over a 12- to 24-month period and evaluating trends for consistency and likelihood of continuance.

Key Takeaways

  • Lenders typically require a minimum 12-month history of variable income receipt to consider it for qualification, with a 24-month history preferred and often required by agency guidelines .
  • Variable income is averaged over the documented period, but if income is declining year over year, the lender must use the lower figure or provide written justification for using the higher average.
  • All variable income types require evidence of likelihood of continuance; lenders verify this through employer statements, historical patterns, and the nature of the employment.
  • The two-year average is the default calculation method, but lenders may use a shorter period if there is documented justification, such as a recent job change within the same field with comparable or better compensation.
  • Declining variable income is one of the most common reasons for mortgage qualification issues; a downward trend triggers additional scrutiny and may result in the lower amount being used or the income being excluded entirely.
  • Variable income that has been received for less than 12 months is generally not eligible for qualification under conventional guidelines, though some non-QM programs may have different thresholds .

How It Works

The Two-Year Averaging Framework

The standard approach to calculating variable income for mortgage qualification involves averaging the income over a two-year period. The lender collects the borrower’s two most recent years of W-2s, federal tax returns, and recent pay stubs showing year-to-date earnings. For each variable income component (overtime, bonus, commission), the lender calculates the total received in each of the two preceding calendar years, then divides by 24 to produce a monthly average. If the borrower has a year-to-date figure from the current year that covers a meaningful period (generally at least several months), the lender may incorporate that figure into the averaging calculation by annualizing the year-to-date amount and computing a weighted average across the available data points. The specific calculation method varies slightly by agency and by lender overlay, but the underlying principle is the same: establish a stable, representative monthly income figure from inherently variable data.

Declining Income Analysis

When variable income shows a declining trend, lenders apply heightened scrutiny. Declining income is defined as a year-over-year reduction in a variable income component. For example, if a borrower earned $18,000 in overtime in 2024 and $12,000 in overtime in 2025, the trend is declining. Under Fannie Mae guidelines, if the trend is declining, the lender must document the reason for the decline and determine whether the lower amount should be used for qualification rather than the two-year average . Some lenders will automatically use the most recent 12-month figure when income is declining, effectively discarding the higher prior-year figure. Others will exclude the income component entirely if the decline is significant (for example, greater than 25% year over year) and unexplained. The borrower may need to provide a letter of explanation or obtain employer verification confirming that the variable income is expected to continue at current or improved levels.

Likelihood of Continuance

For any variable income to be included in the qualifying calculation, the lender must establish a reasonable expectation that the income will continue for at least three years . This is assessed through several factors: the borrower’s history of receiving the income, employer policies regarding overtime availability or bonus structures, industry norms, and any written statements from the employer about future expectations. If the borrower recently changed jobs, the new employer’s compensation structure must support the same variable income type. A borrower who earned commissions at a prior employer but moved to a salaried position without commissions cannot use the historical commission income for qualification.

Calculation Methods by Income Type

While the two-year average is the default, lenders may apply slight variations depending on the variable income type. Commission income earned by a borrower with less than 25% of total compensation from commissions may be treated differently than commission income comprising the majority of compensation . Overtime and bonus income are generally averaged over the full two-year period, though the lender will verify with the employer that overtime opportunities are expected to continue and that bonuses have a recurring pattern. Each variable income type has specific documentation and verification requirements, which are addressed in the dedicated pages for commission income, bonus income, and overtime income.

Year-to-Date Income and Annualization

When incorporating current-year income into the calculation, lenders annualize the year-to-date figure by dividing the total variable income received by the number of months elapsed, then multiplying by 12. This annualized figure is then compared against the prior one or two years. If the annualized current-year figure is higher than prior years, the lender may use the two-year average rather than the higher current-year projection. If the annualized figure is lower, the lender may use the lower figure or investigate whether the decline is seasonal or structural. Proper annualization requires that the year-to-date period cover enough time to be representative; a January pay stub with one month of data is generally insufficient to annualize reliably.

Related topics include mortgage lenders calculate income, commission income mortgage guidelines, bonus income mortgage guidelines, overtime income mortgage guidelines, debt-to-income ratio explained (dti), and common income mistakes that cause mortgage denials.

Key Factors

Factors relevant to Variable Income Averaging (Overtime, Bonus, Commission)
Factor Description Typical Range
Income Type Whether the variable income is classified as overtime, bonus, commission, or other variable compensation Each type has specific documentation and continuance requirements per agency guidelines
Averaging Period The length of the historical period used to calculate the average monthly variable income 12-month minimum history; 24-month history is standard for most agency and conventional programs
Trend Direction Whether variable income is increasing, stable, or declining year over year Stable or increasing trends support full averaging; declining trends may result in use of lower figure or exclusion
Percentage of Total Income The share of variable income relative to the borrower's total gross compensation Higher percentages (e.g., >25% of total compensation) trigger more detailed analysis and documentation
Documentation Completeness Whether the borrower has provided all required W-2s, tax returns, pay stubs, and employer verifications Incomplete documentation may result in exclusion of the variable income component
Employer Verification of Continuance Written confirmation from the employer regarding the likelihood that variable income will continue Required when variable income is a significant component of qualifying income

Examples

Stable Overtime Income Averaged Over Two Years

Scenario: A registered nurse earned $8,400 in overtime in 2024 and $9,100 in overtime in 2025. Her year-to-date pay stub in April 2026 shows $3,200 in overtime through four months. The lender calculates: two-year total overtime = $17,500, divided by 24 months = $729/month. The annualized 2026 overtime ($3,200 / 4 x 12 = $9,600) is consistent with the prior two years.
Outcome: The lender includes $729/month in overtime as qualifying income. The stable, slightly increasing trend supports the full two-year average. The employer's verification of employment confirms that overtime is available and expected to continue.

Declining Bonus Income Triggers Lower Qualifying Amount

Scenario: A sales manager received a $25,000 bonus in 2024 and a $14,000 bonus in 2025. The two-year average is $19,500/year or $1,625/month. However, the year-over-year decline is 44%, which exceeds the threshold the lender considers acceptable for straight averaging.
Outcome: The lender uses the 2025 bonus amount ($14,000/year or $1,167/month) as the qualifying figure rather than the two-year average. The borrower's maximum qualifying income is reduced accordingly, which lowers the maximum loan amount.

Insufficient History Excludes Commission Income

Scenario: An account executive started a new commission-based role 8 months ago after leaving a salaried position with no commission component. The borrower has earned $22,000 in commissions over the 8-month period and wants to include this income in the mortgage application.
Outcome: Because the borrower has less than 12 months of commission income history and did not earn commissions in a prior role, the lender cannot include commission income in the qualifying calculation under conventional guidelines. The borrower must qualify on base salary alone or wait until a 12-month (or 24-month, depending on program requirements) commission history is established.

Common Mistakes to Avoid

  • Assuming variable income will automatically be included in qualifying income

    Variable income is only included if the borrower can document a sufficient history of receipt (typically 12-24 months), demonstrate a stable or increasing trend, and provide employer verification of likely continuance. Borrowers who receive variable income irregularly or have started receiving it recently may find it excluded entirely.

  • Not disclosing a decline in variable income before application

    Borrowers sometimes apply based on their best year of variable income without disclosing that the current year is tracking lower. The lender will discover the decline through year-to-date pay stubs and VOE, potentially resulting in a last-minute reduction in qualifying income and loan amount.

  • Conflating gross variable income with net qualifying income

    The variable income figure on a pay stub is gross income. Lenders use the gross figure for averaging, but DTI calculations compare this against gross monthly income inclusive of all sources. Borrowers should not confuse the gross variable income amount with take-home pay when estimating their qualifying capacity.

  • Changing jobs shortly before application and expecting prior variable income to count

    If a borrower leaves an employer where they earned overtime or commissions and moves to a new employer with a different compensation structure, the historical variable income from the prior employer generally cannot be used. The borrower must establish a new history at the current employer.

Documents You May Need

  • Most recent 2 years of W-2 forms
  • Most recent 2 years of federal tax returns (all pages and schedules)
  • Most recent 30 days of pay stubs showing year-to-date variable income breakdowns
  • Written verification of employment (VOE) with variable income breakdown by year
  • Employer letter confirming likelihood of continuance for variable income
  • Year-to-date earnings statement (if not on pay stubs)
  • Most recent 2 months of bank statements (if required to corroborate deposits)

Frequently Asked Questions

How far back do lenders look when averaging variable income?
The standard lookback period is two years. Lenders collect W-2s and tax returns from the two most recent calendar years and may incorporate year-to-date earnings from the current year. A minimum 12-month history of receipt is generally required, with 24 months preferred.
What happens if my variable income is increasing year over year?
If variable income is increasing, most lenders will use the two-year average as the qualifying figure rather than the higher current-year amount. This protects the lender against the possibility that the increase is temporary. Some lenders may give additional credit for a strongly increasing trend if supported by employer verification and industry conditions.
Can I use variable income from a side job or second employer?
Yes, but the same averaging and documentation requirements apply. The borrower must have a minimum 12- to 24-month history of receiving the income, must provide W-2s or 1099s from the second employer, and must demonstrate that the secondary employment is expected to continue. The lender will also assess whether the borrower's schedule realistically supports both positions.
Does seasonal employment income count as variable income?
Seasonal income is treated similarly to other variable income in that it must be documented over a two-year period and averaged. The lender verifies that the borrower has a consistent pattern of seasonal employment and that the income recurs annually. Gaps in employment during the off-season are expected and do not disqualify the income, provided the pattern is established.
If my variable income was zero in one of the two years, can I still qualify?
If the borrower received no variable income in one of the two years used for averaging, the two-year average will be significantly reduced (effectively halved). Some lenders will exclude the variable income entirely if there is not a consistent pattern of receipt across both years. The borrower may need to qualify on base income alone.
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