Preparing your taxes can have a significant impact on your home buying potential. There are a lot of moving parts in the approval of a home loan, and if you’re going through the home buying process for the first time, it can be confusing. You probably have a lot of questions, so let’s address some of the most common ones here.
Why do lenders need your tax returns?
No lender wants to sell you on a loan you can’t afford. By asking for your tax returns, the lender gets a good idea of what you can afford to pay every month for a mortgage.
What do mortgage lenders look for on tax returns?
Because your mortgage loan represents years of monthly payments, a lender needs to know that you can afford the loan both now and in the future. Your tax returns paint a good picture of your earning potential, other sources of income, your deductions, and your net income.
What do underwriters look for on tax returns?
Mortgage underwriters look for your loan-eligible income on your tax returns. Sometimes, you have income that doesn’t qualify to be counted toward the mortgage approval process. If you list a source of income on your home loan application that doesn’t show up as income on your tax return, it won’t be counted. Underwriters also look at your debt to income ratio (how much money you owe in comparison to how much money you make every month), and your income stability.
Is there any way to prepare your tax returns for a smoother mortgage process?
Are you looking to purchase or refinance a house in the first half of the year? If so, it is a good idea to file your tax returns as early as possible to prevent any delays in your mortgage process. Because it can take up to 8 weeks for the IRS to process your tax return, the sooner you file the sooner you’ll have the information your lender is looking for, especially if your mortgage application approval depends on your income for that year.
It is very important to use a lender that understands and prepares your income calculations correctly for underwriting, especially if you are self-employed. At Skyridge Lending, we will typically add back for mileage, depreciation, and amortization (to name a few of the items), and this will help strengthen your income and qualifying loan amount by giving you additional qualifying income. We will also back out any business debt that can be documented (usually by proving the business has paid the debt the past 12 months) out of your personal debt to income ratio.
Why wouldn’t a lender require a tax return?
If you are self-employed and deduct business expenses from your income, your tax returns may not reflect your actual income. This benefits you by lowering your tax burden, but it also makes your income appear lower than it really is, which may cause some lenders to reject your application for a home loan. This is when you need to look at mortgage lenders for self-employed buyers, also sometimes called 1099 mortgage lenders. Many lenders recognize that tax returns may not always be the best way to measure a borrower’s income, which is why they offer non-qualified mortgages to help address this issue. In this instance, lenders use your bank statements and/or 1099 forms to verify your actual income instead of tax returns. These loans are sometimes called bank statement home loans.
At Skyridge Lending, we also offer many versions of asset for income programs, where your assets can be used in lieu of your income.
How does this mortgage process differ from a traditional home loan?
The process for a bank statement mortgage is similar to that of a traditional home loan. The lender will check your credit score, ask for certain financial documents, get you a preapproval amount, and usually give you a letter stating that amount to include with any offer you put on a home. Once you have that preapproval amount, you can look at homes in that price range and be fairly certain that you’re in a good position to put in offers. You can shop around for the right lender and the right real estate agent to help you find the right home that you can afford.
Mortgage interest deduction
If you’ll be taking out a mortgage to buy a house this year, you might be able to take a mortgage interest deduction on your federal income tax return. This is a common itemized deduction on your schedule A which allows homeowners to deduct the interest paid on a qualified residence loan, which is considered any loan that is used to purchase, build, or make substantial improvements to a primary or secondary residence, provided as of 2020 tax law:
- You itemize your deductions
- Your mortgage is for your principal residence or one other qualified residence
- You paid or accrued the interest during the tax year
- You used the loan proceeds to buy the home that secured the mortgage
- As of 2018, you can deduct interest on up to $750,000 of a qualified residence loan if you are a couple filing jointly
- Couples filing separately can deduct interest on up to $375,000 of a qualified residence loan
Under the Tax Cuts and Jobs Act, the amount decreased from $1 million ($500,000 for couples filing separately). However, if you acquired your home loan before Dec. 15, 2017, the previous limits still apply to your mortgage interest deduction.
Give our mortgage professionals a call, at 833-SKYRIDGE, to learn more about how we can help you increase your home buying potential. We are happy to help answer any mortgage-related questions and/or provide tax filing tips so that you can be well-positioned for your home purchase this year.