When you’re ready to apply for a mortgage loan, you can expect to submit a bunch of documentation. This is one of the biggest loans you’ll ever receive, and naturally, mortgage underwriters need to ensure your ability to repay it. This financial documentation will also include tax returns of 1 to 2 years. You’re probably wondering why underwriters would need to see your tax returns, and we have all the reasons explained along with advice on making sure your tax returns are good enough to qualify you for your mortgage loan.

Why do mortgage lenders look for tax returns?

1. They use tax returns to verify your income
2. Typically over a 2-year period (though sometimes one year will suffice)
3. They may also take note of rising or falling income
4. And ask for an explanation if applicable

Tax returns verify your income

Perhaps most importantly, lenders use your tax returns to verify your income. Your tax documents give lenders information about your various types and sources of income and tell them how much is eligible toward your mortgage application. Non-recurring income, such as any money received as a result of a one-off company signing bonus, a boat sale, or lottery winnings, wouldn’t typically be counted as loan-eligible income. Lenders use the income declared on your returns to determine the amount of money they are willing to loan you, as well as to assess your ability to repay the loan.

Tax returns determine your level of risk

Your reported income is also used to determine your debt-to-income ratio, which is simply the percentage of your monthly gross income that is used to pay your monthly debts. The higher your debt-to-income ratio, the higher the lender’s risk, and lenders are always concerned with risk. They will also ask you to fill out a form 4506-T, which is a request for tax return transcripts. This is done to make sure everything matches up and to prevent fraud. So, don’t submit bogus tax returns. If you claim a ton of business expenses, be careful that they don’t reduce your taxable income to the point where you no longer qualify.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio gives lenders an understanding of how much of a monthly mortgage payment you can afford in addition to your current debt responsibilities without financial difficulty. It is calculated by taking your current monthly debt payments (credit card bills, car payments, student loans, etc.) plus your future monthly mortgage payment and dividing it by your gross average monthly income — then multiplied by 100 to get the DTI expressed as a percentage.

Tax returns reveal your character

Character is defined as the mental and moral qualities distinctive to an individual. Banks want to loan money to people with good credentials and references, but they also consider how you take responsibility. If you have not fulfilled your obligation to file your business income taxes, this negatively impacts your character for both lenders and the SBA. The SBA will not approve a loan application if you have not filed your taxes properly.

Preparing for mortgage lenders

Pinpoint Potential Red Flags Before the Lender Does:

1. A home loan application is like a job interview
2. You only get one chance to make a good first impression
3. Make sure you take a hard look at all your financials
4. Before the lender does to avoid any missteps

Affiliated Mortgage has a team of highly experienced loan officers and real estate agents who can help you make your dream of homeownership a reality. We are a top-rated mortgage company in Rapid City SD, ranked as the most trusted mortgage lender in Billings MT, and the top mortgage broker in Sioux Falls SD. Contact us today to get pre-qualified now!