Tax transcripts are official transcripts obtained from the IRS. The use of these transcripts is to verify that the tax returns you provide to a lender are legitimate and not altered in any way. There are certain situations when the transcripts are required and also certain situations when the lender does not have to execute the IRS Form 4506, but may choose to do so in order to satisfy their own requirements since it is their right to add their own overlays onto the standard Fannie Mae requirements.
When are Tax Transcripts Required?
Tax transcripts are necessary whenever you need to provide your tax returns to qualify your income for a mortgage. This includes borrowers that are self-employed, work on commission, or get a great deal of overtime in addition to their regular salary. If you want this type of income included in your qualifying income, tax returns are necessary in order to qualify. If you must provide full tax returns, Fannie Mae requires that the lender verify those tax returns with the IRS. Form 4506 helps the lender obtain a transcript and compare it with the tax returns you provided to them at the time of application for the loan. If the amounts match, the loan can close as planned. If the amounts do not match, however, further verification will be necessary. Following are the circumstances that would warrant a lender to ask for your tax returns:
- Commission income that totals more than 25% of your regular income
- Income you receive from a family member that is also your employer (family owned business)
- Income from a rental property if you use it for qualification purposes
- Seasonal income
- 1099 income
- Interest income
- Self-employment income that totals more than 25% of your income
- K-1 income
When are Tax Transcripts not Required?
Not every self-employment or commission situation will require tax returns or tax transcripts. The basic rule is that this type of income must make up at least 25% of your income in order for tax returns to be required. For example, if you work overtime, but the income does not equal 25% of your regular income, it can be verified with your paystubs and W-2s alone. The same is true for self-employment income that you may have on the side or commission income that your employer pays you. Other types of income that do not require tax returns or tax transcripts include:
- Social security income
- Military income
- Disability income
Any of these types of income can be verified using W-2s and paystubs or a letter from the party providing the income on their letterhead along with bank statements to show receipt of the income.
Not a Pre-Closing Concern
Form 4506 must be executed, but it is typically not a condition to close the loan, unless there is reason to suspect that the borrower’s tax returns are not legitimate. Every lender can use their own judgment when it comes to determining if a borrower is legitimate or not. If the income is determined as legitimate, the lender is required to execute the 4506 at closing. In addition, you sign a document at closing stating that everything is accurate and true that you provided on your application.
What do Lenders Look at Tax Returns For?
You might wonder why lenders require tax returns in the first place. It makes sense if you do not have paystubs or W-2s to document your income, but what about the cases where you do have those documents, such as commission income or overtime income? Why is there the double requirement to verify your income? The answer is simple – the lender needs to determine if there are any unreimbursed expenses that you pay in order to hold that job. Fi there are such expenses, they must be deducted from your income and/or included in your monthly debt ratio.
This requirement is only put in place when you have self-employment, commission, or overtime income that exceeds 25% of your income. If this income does not exceed that amount, the expenses are not required to be included in your debt ratio or deducted from your income. In most cases, if you have self-employment on the side or you work on commission but only slightly, the debts you incur will report on your credit report, enabling the lender to include it in your debt ratio anyways.
Not all rental income situations require you to provide tax returns and tax transcripts. If you obtained the rental property after completing your most recent tax return, it will not report on there, but you are still eligible to apply for a mortgage. In these cases, you simply must report the rental on your mortgage application, along with any loss or profit you make in regards to the property. The lender will likely be able to figure out the debts you incur for this property based on your credit report, helping the lender make a sound decision when it comes to your loan application.
Tax transcripts can take a while to come into the lender, so if you know the lender will require them, ask for the forms to be executed as early as possible. In most cases, lenders wait until the closing to execute the document, since Fannie Mae requires them as a part of the post-closing package the lender sends to them. You have nothing to fear if tax transcripts are required as long as you provided accurate tax returns to the lender. Any type of fraud will be uncovered with the tax transcripts, so it is not worth taking a chance with the process. In general, transcripts do not hurt your case when it comes to applying for a loan – as long as you are open and honest and let the lender include all expenses/income in your application in order for the lender to create the most accurate picture of your financial situation.