Lenders need to verify your income in order to approve you for a mortgage. Does this mean that every lender will ask for your tax returns, though?
Luckily, the answer is ‘no.’ Not everyone has to provide his or her tax returns. Only certain borrowers must provide these documents to prove their income. If you are an employee of a company and receive salaried or hourly income, you don’t need to provide your tax returns. If you aren’t employed by someone else or you don’t receive salary or hourly income, you may need to provide them, though.
Keep reading to learn more.
Are you Self-Employed?
This is usually the trigger that prompts lenders to ask for your tax returns. When you work for yourself, you not only have irregular income, but you have many expenses you must cover. When you work for someone else, you don’t have unreimbursed expenses, or at least most people don’t. Your employer pays you and even takes the taxes out of your check for you.
Working for yourself means that you are responsible for all taxes as well as other expenses that occur when running a business. Lenders will look at all of the expenses that you wrote off on your taxes. They may deduct certain expenses from your income to qualify you for a loan. Lenders also use your tax returns to make sure that you claim the income that you make. If you have any income that you don’t claim, lenders can’t use it for qualifying income.
Lenders use your tax returns to determine your income stability. It’s commonplace to have cyclical income, depending on the type of business that you own. If a lender were to qualify you during a busy time of year, they may over qualify you for a loan that you can’t afford during slower times. If they qualify you during a slow time of year, they may not qualify you for as much loan as you can afford. Using your tax returns for the last 2 years, lenders can take an average of your income. This should leave you with a loan that you can afford any time of year.
Do you Work on Commission?
Even if you do work for someone, if you don’t collect a W-2, the lender will need your tax returns. This is most common with borrowers that work on commission. These borrowers generally receive a 1099, rather than a W-2.
Lenders want to see your tax returns for many of the same reasons they need to see self-employed borrowers’ tax returns. They need to see your unreimbursed employee expenses. They also need to average your income over the two years to make sure that they don’t over qualify or under qualify you for a loan.
Watch What you Claim
This is a little word of caution for those that do need to provide their tax returns to lenders. If you know you’ll apply for a mortgage in the next year or two, watch what expenses you write off on your taxes. While we know that you’ll decrease your tax liability, which is likely what you want to do, it can hurt your bottom line income. Remember, lenders have to take out certain expenses that you claim from your income. This lowers your income and could increase your debt-to-income ratio. This could put you at risk for losing your ability to get a loan.
While your tax liability will increase for a year or two, it’s a good idea to take it easy on the write-offs. Pay the higher taxes and enjoy the higher loan amount that you can get as a result of the lower debt-to-income ratio. Of course, you can also pay down your debts to keep your DTI low, but your total income is what ultimately determines the housing payment that you can afford.
If you do need to provide your tax returns, you’ll need to provide all schedules of your taxes. Some lenders want both personal and business tax returns, while others just want personal tax returns. Either way, make sure that you limit your write-offs and get the loan that you can afford not only during the busy times of the year, but year-round.