If you are applying for a mortgage, you are likely getting a lot of paperwork together. If you aren’t, you should be because lenders need a lot of documentation today. One thing that many borrowers worry about is if they will have to share their tax returns with the lender. So will you be one of them?
The answer isn’t cut and dry because some borrowers do have to show their taxes, but not every borrower has to do this. Keep reading to learn which borrowers have to supply their taxes and which do not in order to secure a mortgage.
What Type of Employee are You?
First, take a look at what type of employee you are as that will indicate if you have to share your tax returns. Do you work for someone else?
If you answered yes, then ask yourself, ‘do you receive W-2s’? If so, then that’s all you need. Your lender will ask for your last month worth of paystubs and your W-2s from the last two years. There’s very little chance of the lender needing your taxes as they have the proof of your income that they need with your paystubs and W-2s.
If you answered ‘no,’ to the question ‘do you work for someone else?’ then you may have to supply your tax returns. If you don’t work for someone, then you likely own your own company. There’s no neutral third party here to verify your income. In order to make sure it’s legitimate, the lender will need to see your taxes. Generally, they will want to see your taxes from the last 2 years in order to come up with a 2-year average of your self-employment income.
There’s one grey area here that we have to cover. You might wonder what happens if you work for someone, but you don’t get paid W-2s. Maybe you are a contractor or you are paid on commission. Your employer may pay you on a 1099. This works the same as if you worked for yourself. You have to prove to the lender that you make the income you claim. While you may be able to supply paystubs to show your income, your lender will also need your tax returns to further prove your income.
What Lenders Look for In Tax Returns
Does it bother you that a lender might need to see your tax returns? Generally, they shouldn’t see anything on there that they don’t already see if they have your other financial information. It’s just a confirmation that you make the income you say you make.
There’s one more thing they look at, though. They also look at the expenses you write off on your taxes. This is where the real problem lies. If you are self-employed, you are responsible for both sides of the taxes (the employee and the employer). Many self-employed borrowers try to decrease this risk by writing off certain expenses. This is a perfectly legal move, but it’s one that decreases your adjusted gross income. Lenders are required to use that adjusted gross income in order to come up with your debt ratio. If you write off too much, it can hurt your chances of loan approval.
Getting Around the Need for Tax Returns
If your tax returns will truly ruin your chances of loan approval, you have one other option. You can apply for an alternative documentation or stated income loan. Don’t worry because these are not the same loans that shut the housing industry down in the early 2000s. The loans have undergone tremendous changes.
Now, instead of providing your tax returns, you can provide lenders with your bank statements. They will usually need the last 12 – 24 months of bank statements to determine your income. This gives lenders the chance to use your ‘full income’ rather than the bottom line income that you claim on your taxes. Now they still might deduct the standard expenses that someone in your industry has, but it won’t be anything near what you probably wrote off on your taxes.
In order to qualify for this type of loan, though, you’ll need good credit and not have plenty of assets on hand. Lenders usually require a higher down payment than conventional or FHA loans and they will want you to have money on hand after the closing to give you an alternative way to pay your mortgage should something happen to your income.
If a lender asks you for your tax returns and it makes you worry that you won’t get approved, know that you have options. You may even shop around with different lenders to see what they have to offer. If you are a salaried employee that gets paid regularly and has a W-2, though, chances are that you will not need to provide your tax returns to the lender.