Why mortgage lenders want full tax returns
A few years ago, lenders often required little or no documentation of a buyer's income. That's not the case today.
Shopping for a home-mortgage loan? Prepare to hand over real proof of your taxable income.
During the housing boom, lenders rarely required borrowers to provide copies of federal tax returns.
But today, lenders often ask borrowers to turn over entire tax returns, according to Brad Blackwell, national sales manager for Wells Fargo Home Mortgage.
"Often people will think they can bring in the first two pages of the tax return, and what they need to bring is the full tax return and all schedules because a person's full income picture is contained in the entire set of documents, not just the first two pages," he says.
Borrowers generally also will be required to sign a Form 4506-T, which allows the lender to retrieve a tax transcript from the Internal Revenue Service.
Joe Metzler, a mortgage specialist at Mortgages Unlimited in St. Paul, Minn., says lenders use the 4506-T tax transcript to compare the borrower's W-2s to his or her reported income. If the numbers match, all is well. If not, the lender will dig deeper.
Why the sudden interest in borrowers' tax returns?
The short answer is that lenders are looking for income irregularities and evidence of loan fraud.
In most cases, "all aspects of the tax return [will be] examined to determine what the borrower's income is," Blackwell says.
That means the lender not only will look at reported income but also at items such as:
• Unreimbursed employee business expenses: These so-called "2106 business expenses" typically are subtracted from income, according to Julie Miller, a sales manager at Prospect Mortgage in Irvine, Calif.
Examples include uniforms, union dues, mileage, expenses related to a cellphone used for business, marketing costs and training costs.
"If somebody makes $70,000 to $80,000 a year, but writes off $20,000 in business expenses, that is allowing them to reduce their taxable income, but we have to subtract that for qualifying purposes," she says.
• Rental-property income: This must be documented and shown on the tax return, unless the property was purchased in the current calendar year. In that case, the rent must appear on consecutive monthly bank statements, Miller says.
"If you take in $1,000 a month in [rent], but you have $900 a month in expenses for owning the property, then you really only have $100 a month in positive rental income," she says. "And if you take in $1,000 a month, and you don't report that on your tax returns, you can't use that income at all."
• Business losses: These include losses incurred by a spouse's business, according to Metzler.
For example, suppose one spouse earns $100,000 per year as an employee. The other spouse has a business that generated a $40,000 loss shown as a write-off on the couple's tax return. The lender will subtract $40,000 from $100,000 to yield a combined taxable income of $60,000. That might not be enough income to qualify for as large a loan as the borrower wanted.
• Depreciation expenses: On the flip side, depreciation expenses taken on a home office, business equipment or other asset could increase a borrower's loan-qualifying income, according to Blackwell. "I want to stress 'may,' " Blackwell says. "An underwriter may be able to add that back."
• Capital gains: These also may be counted as income — or not. "If the capital gain is a one-time event, we probably won't count it as income because the borrower can't show it to be sustainable," Blackwell says.
Lenders' scrutiny of tax returns can present a big challenge for borrowers who are self-employed, according to Peter Ogilvie, president of First Residential Mortgage in Santa Cruz, Calif.
"Many self-employed borrowers — real-estate agents to shoe-store owners — are having a really difficult time getting loans because their accountants and bookkeepers are trained to minimize their income to save them on taxes," he says.
The solution isn't easy: Taxpayers need to "bite the bullet," to use Ogilvie's expression, and build up their taxable income for two years before they can qualify for a loan. Some may have to forgo deductions to which they believe they are entitled and pay more income tax so they can show more income on their tax return to qualify for a loan.
Borrowers who try to amend a prior year's tax return to show more income after the fact may be disappointed to learn this strategy won't work. Instead, an amended tax return can trigger a loan denial, according to Metzler.
"The very creative loan officer would say, 'Go back and amend your tax return to show some income, so you can qualify,' " he says. "So now there is a new rule that says you cannot qualify for a mortgage if your tax return has been amended."