What Tax Returns Mean to Lenders

There are lots of documents a home buyer needs to gather in order to apply for a home loan—one of which is your tax return.  Now that it’s tax season, those of you who are thinking about taking out a home loan, are also thinking about how to file.  Here are some of the major things that banks look for when qualifying someone for a loan.

While some lenders will accept W-2s to prove your income, most likely you will still have to sign Form 4506-T, a request for tax return transcripts, wait— transcripts? Are we in college again? While it’s not exactly like college, it is a lot like applying for your first big job.  They want to check out your qualifications and credentials to make sure you’re the right fit for them and they’re the right fit for you.

When looking over your tax returns, one of the major things lenders look at are trends in your earning.  They want to see if your income is stable, increasing, or taken a hit.  If your business has reported a loss, that will be deducted from your annual income.  However, if your business shows an increase, that can be an extremely positive asset to your application.

Unfortunately, if you’re self-employed like a growing number of Americans, tax filing is a little more complicated than mere W-2 mortals.  The key is to be extremely organized— as if you don’t have enough to do!  Separate accounts are very helpful, but at the very least, a business phone number.  If you're earning enough to apply for a home loan, banks have a better time believing your earnings if business calls don't go to your personal line.

“Zero-ing out” is not necessarily an option if you’re looking to buy a home.  Writing off mileage, marketing, or home office space is the cornerstone of a Self-Employed tax return, however, reducing your taxable income makes it appear on paper that you’ve earned less than you actually do.  Be particular about what you choose to write-off, banks like to look at 2 consecutive years of returns.  

It’s not all bad news.  If you currently own a home, there are certain things you SHOULD write-off:
-Property Taxes
-Mortgage Interest
-Private Mortgage Insurance (PMI)
-Depreciation or expenses on investment properties

Taxes have a serious effect on eligibility for a home loan.  If you owe taxes, it is necessary to either pay it off or be on a payment plan.  Any tax liens on your credit report will deem you ineligible for a mortgage.

The bottom line is, by looking at your return is the best way for lenders to see you are capable of repaying the loan.  If you are self-employed and planning on buying a house, it may be a good investment to hire a professional to help you with your return.  They can help represent your true income to your lender through a smart tax return, optimizing what you could potentially qualify for! 


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