Why Do Mortgage Lenders Ask For Your Tax Returns To Approve A Home Loan
One of the largest loans that you receive is a home loan. So, lenders need to evaluate your financial status to ascertain whether your income will cover the mortgage payment and other monthly debts. For this you need to be ready to submit a bunch of documentation which includes your paystubs, W2s, and your income tax returns for the previous two years.
Why do underwriters ask for your tax returns?
Underwriters work for mortgage lenders to evaluate your financial status and determine whether you qualify for a home loan or not. For this, your tax returns are an important document as it informs them about your actual gross income, including other forms of income like alimony/child support, overtime, etc.
To find out your monthly qualifying income underwriters look at:
- Your income stability (income is steady, dropping, or rising) over the last two years.
- Debt-to-income ratio: To ensure that you have enough income each month to pay for your home loan without it affecting your other monthly debts.
Types of Income verified for mortgage approval
Here is a list of income that underwriters can fully or partially verify by using your tax returns
- Pension and Annuities
- Social Security
- Capital Gains
- Dividend Income
- Business Income (Schedule C)
- Rental Income (Schedule E)
- Alimony Received
- Farm Income
- Partnership and Other Self-Employed Income
- IRA Distributions
- Interest
The lender may also ask you to fill out a Form 4506-T. This is a request to obtain a copy of your IRS transcript. The underwriter will scrutinize your tax return in comparison with your IRS transcript and if there are any discrepancies on the transcripts it will have to be addressed by the borrower and can cause delays in the mortgage process or even get rejected. So, you should provide accurate, verifiable information to ensure that your mortgage process goes off smoothly and your loan gets approved.
A few things that can affect your mortgage qualification:
- Any decline in your income in the past two years: If your income has decreased from the past year to the current filing period then it can be a problem that will have to be discussed with your lender.
- If you deduct any unreimbursed business expenses on your tax return (Form 2106), such as union dues, uniforms, mileage for work travel, mobile phones needed for business purposes, meals, and entertainment. Then, this will be subtracted from the income you can use to qualify for a home loan.
- Schedule C Filing for self-employed or individuals having a side business: Writing off expenses or showing negative income can affect your mortgage even if it is not your primary form of income. You will also not be able to modify your previous tax returns to qualify for the loan.
- Schedule E Real Estate: If you have converted a primary or secondary property into a rental property or purchased an additional property then it can affect the net income/loss numbers from the previous year.
Tax Deductions
- Timing of filing taxes is important as the IRS takes four to eight weeks to process your taxes. So, if your mortgage pre-qualification depends on the income reported for the current year you should file them early as it has to be processed and verified by IRS before it can be used for the qualification process.
Tips: Tax deductions will help you pay less in taxes but may not be beneficial with the loan approval. Tax deductions will lower your gross income and this, in turn, will lower the amount you can borrow. You can boost your income if you hold back your tax deduction a few years before you apply for a mortgage. Also if you utilize many deductions, you will find it difficult to qualify for a home loan. You can either consult a tax professional or use tax preparation software, to see if buying your dream home is worth paying more taxes for a year or two.
Bottom line
Every mortgage lender has their own requirements. Some lenders may not require tax returns if your only source of income is your salary. However, you must make sure to ask your lender what documents are required and be prepared to submit them as soon as possible. This will speed up your application process.
