“Nothing to see here,” seems to be the stance of Republican Presidential Nominee Donald Trump when pressed about his non-public release of income tax returns. And yet tax returns are required when getting a mortgage. If you were to believe Mr. Trump, why the need to submit federal tax returns with your loan application? Will tax returns help make or break your mortgage deal?
Tax Returns, Lenders and You
Income verification is an important aspect in any mortgage underwriting process. And tax returns provide lenders a clearer if not a complete picture of your income. As financial planners put it, tax returns represent the “best way to gauge a person’s financial health”.
A two years’ worth of federal tax returns lets lenders see fluctuations in your income: is it going up, down or steady? Aside from income, lenders will be able to look into your expenses, taxes, financial obligations and more. Scrutinizing your income using tax returns helps lenders in qualifying you for a mortgage: if it’s a go or a no. And if you qualify for a loan, how much is the lender willing to lend you.
Federal tax returns also provide lenders with an extra layer of protection from fraudulent loan transactions. Not so long ago, there was the housing bubble when mortgage loans were handed at no/low documentation to borrowers.
Nowadays, tax returns have been put into good use to verify borrower’s income, spot any irregularities, and avoid income misrepresentation. Then, tax returns were optional; now, they’ve become a fixture of any loan documents checklist.
Tax Returns, Sections and Transcripts
To show proof of income, you are required to submit pay stubs dating back to the last 30 days with year-to-date earnings and Form W-2 for those employed during the last two years. Form W-2 is a wage and tax statement that should be filed by an employer with the Internal Revenue Service.
These documents will go together with your federal tax returns, which should include the latest return and possibly returns for the last two years, via Form 1040. Lenders will examine each tax return, taking note of certain items for mortgage underwriting purposes, including:
- Employee Business Expense: This is defined as necessary and ordinary expenses incurred by an employee as part of his/her work. These may be uniforms, cellphone costs, union dues and more. Sometimes, these unreimbursed job expenses included in Form 2106 attached to Form 1040 can make a difference in qualifying or not qualifying you for a mortgage.
- Business Income (Loss): It represents the loss or profit from a business you operated or from a profession you practiced as a sole proprietor. Lenders would subtract any business loss from any income earned to get a combined taxable income in the case of married couples.
- Rental Property Income: Lenders take into account the rent on the property vis-a-vis the expenses for owning the property.
- Capital Gain (Loss): It is the difference between how much you paid for a capital asset, e.g. house, and how much you sold it for (at a loss or a gain). This may be counted as an income or not.
- Depreciation Expense: The depreciation expense on a fixed asset such as a home office, equipment could increase your loan-qualifying income.
Submit your tax returns completely, blank pages, schedules, attachments and all. Don’t change anything as it might invalidate the document or worse lead to loan denial.
In connection with Form 1040, you will be asked to submit a request for a transcript of your relevant tax return to the IRS, Form 4506-T. The return transcript will contain most of the line items of your Form 1040, which information will be relevant to the lender when processing your loan application.
The tax-return transcript is forwarded directly to the lender upon your consent as per your request.
Tax-Returns Challenge for the Self-Employed
The use of federal tax returns in mortgage underwriting analysis is seen as a challenge for some self-employed borrowers – shop owners, real estate agents, etc — whose income may have been adjusted for tax purposes.
Self-employed borrowers have been advised to build their taxable income for two years. That is, if you are running your own business and making money, it should all be on paper. Pay more income tax to show more income on your tax return. Also, ensure that your business-related expenses wouldn’t reduce your income to the point where you no longer qualify for a loan.
If you are self-employed or a regular employee and have questions about tax returns, feel free to talk to an accountant or a financial expert. And on matters concerning mortgage applications and tax returns, consult any of our lenders. »You can find them here.»