Stated-Income

Are Tax Returns Needed to Refinance Your Mortgage?

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You know you have to verify your income in order to refinance your mortgage. Unless, of course, you qualify for the VA streamline or FHA streamline loan. You aren’t required to verify your income if you use a streamline program.

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But just what does it mean to verify your income? Do you need paystubs, W-2s, and tax returns?

There isn’t a straight answer to this question. It depends on the situation. Some borrowers will have to provide their tax returns, while others won’t need to provide them.

Salaried and Hourly Borrowers

Salaried and hourly borrowers typically don’t have to provide their tax returns when refinancing their mortgage. If you make a yearly salary and it stays the same all year, your lender won’t have a need for your tax returns. Your paystubs and W-2s will show the necessary information for the lender to qualify you for the loan.

Hourly employees are also exempt from providing their tax returns. Hourly employees will have to provide their paystubs covering the last 30 days and their W-2s covering the last 2 years. This way the lender can determine a 2-year average of your income. They do this in the event that your hours vary, which would give you varying income. Taking a 2-year average helps the lender account for the highs and lows that your income may experience.

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Borrowers Paid on Commission

If you work on commission and it makes up more than 25% of your income, you will need to provide your tax returns for the last 2 years. Lenders will look at your tax returns to see if you have any unreimbursed employee expenses that they must deduct from your income. They will also look for any deductions that you take that are work-related. Lenders are required to use your adjusted gross income as it is reported on your tax returns. If you claim many deductions, it could affect your ability to secure a mortgage.

Self-Employed Borrowers

Finally, we have self-employed borrowers. These borrowers definitely need to provide the last two years of their tax returns. Just like borrowers paid on commission, lenders need to determine the adjusted gross income of the self-employed borrower.

Because the lender will use your AGI as reported on your tax returns, it works to your benefit to avoid taking too many deductions during the 2 years leading up to your loan application. Even though this will increase your tax liability temporarily, it will also increase your chances of securing a mortgage.

Don’t worry if your lender asks for your tax returns. It’s just another way for them to verify your income. As long as your tax returns are legitimate and they reflect what your paystubs and/or W-2s already show, you are in good hands. The lender will use your tax returns to calculate your gross monthly income, which they then use to determine your debt ratio. This is the lender’s way of determining if you can afford the loan and if you are a high risk of default.

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Are Tax Returns and Tax Transcripts Necessary?

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Requesting transcripts of your tax returns was a common policy for self-employed borrowers before the housing crisis. Today, however, lenders almost always request a transcript to verify your taxes, whether you are self-employed or not.

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Why Lenders Request Transcripts of your Tax Returns

Requesting the transcripts of your tax returns helps lenders verify the information you provided them. It shows that the returns you provided were not altered in any way. In other words, the information you gave the lender is exactly what you gave the IRS.

What is a Tax Transcript?

The tax transcript is not an identical print of your tax returns. Instead, it’s a line item document that shows the same (hopefully) numbers you provided on your tax return. The transcripts do not contain all of the schedules you have on your tax returns, but it will provide the numbers on those schedules. This is what the lender needs.

How Lenders Get Your Tax Transcript

In order for the lender to order your tax transcript, you must sign Form 4506-T. This allows the lender access to your tax transcript. They send the signed document to the IRS who then sends the lender your tax returns within a few weeks. It’s customary to sign the transcript form right away after accepting a lender’s offer so the transcript does not hold up your loan’s processing.

Why Tax Returns Matter

You might wonder why a lender even needs your tax returns. Isn’t paystubs or a P&L from your business enough? Tax returns just provide lenders with more proof of your income. It shows that what you say you claimed on your taxes is truly what you claimed. However, there’s another reason.

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Lenders often request tax returns from borrowers that own their own business or work on commission. These borrowers often claim many expenses on their taxes. These expenses take away from their gross income. The lender can only use the net income you claim on your taxes. So your tax return income may not match the income on your paystubs or P&L. The lender can only use the income on your taxes, though, which may hurt you.

As far as a layer of protection, though, the lender matches the tax returns with your other proof of income. If there is some type of inaccuracy, the lender will start investing the reason. They may come directly to you for an explanation or they may do some verifying on their own. It could greatly delay the underwriting process, so it pays to make sure everything matches before applying for a loan.

If you own your own business, the lender will need to verify that there isn’t a business loss that you tried hiding with your income documents. This is why they use the net income from your tax returns, rather than the documents you provide. If there is a net loss, the lender must use this for qualifying purposes, which could harm your chances of approval. They do add back certain expenses, though, such as depreciation.

One last reason lenders care about your tax returns is to see if you owe the IRS money. This isn’t a deal breaker if you do; however, there are rules. If you owe money, you either have to pay it in full or have a payment arrangement set up. If you have the payment arrangement, you’ll also have to prove that you make your payments on time. There isn’t a specific amount of time you must have the arrangement, but the longer history you can show, the better off you’ll be.

Your tax returns play an important role in your ability to secure a loan. Make sure you provide the ‘real’ returns along with a signed 4506T so that the lender can get the process rolling right away.

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Are Income Tax Returns Required for Mortgage Approval?

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As you get your documents ready for mortgage approval, you probably have many questions. What you need to provide is often the most asked question. How far deep into your income does the lender need to dig? Are your paystubs enough? What about bank statements and income tax returns? Does every applicant have to provide those documents? Every situation is different, but the one answer across the board is that not every person needs to provide tax documents, but you have to meet certain requirements in order to not need them.

How are you Paid?

The first question to ask yourself is how are you paid? Do you receive regular paychecks on a weekly, bi-weekly, or monthly basis? If you do receive paychecks, you are on the right path, but you have to take it one step further. What type of income is that you receive on your paychecks? Do you receive a salary, commission, bonus, or a combination of the three? This is what determines whether or not you need to provide your tax returns for mortgage approval.

If you are a salaried employee and your income never changes unless you get a promotion or raise, you probably do not need to provide anything more than your paychecks and W-2s for the last two years. On the other hand, if your income is fully or partially comprised of commission or bonus income, you will need to provide your income tax returns for verification purposes.

The reason behind the lender requiring your tax returns is for them to compare the income reported on your returns to the income on your W-2s. If there is a discrepancy between the two, the lender needs to figure out the reason why. Generally, it is because people that work on commission and/or bonuses have expenses that come out of their own pocket. These people then write these expenses off, which comes off of the top of their income. Mortgage lenders use the income that you report after the expenses, rather than before for your qualifying income in order to ensure that you can afford the loan.

»Get to know if your income tax return qualifies. Ask a lender today!»

Do you Own a Business?

If you own a business, you will always have to provide your tax returns to the lender for qualification purposes. The tax returns will show the lender not only how much money you bring in, but also all of your expenses. Generally, there are quite a few expenses that business owners write off including depreciation. In addition, many business owners have business losses or capital gains that need to get figured into the household qualifying income to determine if you are eligible for a loan.

What other Income do you Have?

Even if you are a salaried employee with straightforward income and no unreimbursed employee expenses, there is another case where you would need to provide your income tax returns and that is if you are a landlord and rent property out. If you do rent a property out, the lender needs to see what types of expenses you have. They cannot use the amount of rent you charge at face value – they need to see what the net rent is that you receive. For example, if you charge $1,500 per month in rent, but it costs you $500 per month to keep the property maintained and running, then you only take in $1,000 in rent. The lender needs to see these expenses and use the proper income in order to qualify you for the loan.

Income Tax Returns Tell a Story

Your income tax returns help the lender figure out your financial story better than any other document can do. Because most lenders must use the money that you report to the IRS and no other income, you are able to show your true financial worth this way. For example, if you do not claim the rental income you make every month, the lender cannot use it for qualifying purposes. On the other hand, if you have commission income that varies, but you do not write off any expenses, the lender can use the full value of that income on an annualized basis.

The tax returns help the lender figure out what he should do and how risky your loan file really is after digging deeper than your paystubs and W-2s. The tax returns are official documents that must match up with the transcripts of your tax returns the lender can request from the IRS with IRS Form 4506-T. This way you are able to prove your worth alongside your compensating factors, such as assets and good credit in order to obtain the mortgage financing you desire.

»Get to know if your income tax return qualifies. Ask a lender today!»