Why Do Lenders Want Tax Returns

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If you’re applying for a home loan, in addition to other standard paperwork, you may be asked for your tax return. As a result of the housing bust and subsequent economic downturn, lenders have become increasingly wary of making loans that borrowers can’t pay back. Many lending institutions are now interested in a more complete picture of your financial situation than the one provided by a W2. Along with your complete tax returns, you can also expect to be required to sign a Form 4506-T, which gives a lender the right to ask the IRS for a tax transcript.

What Lenders Are Looking For
While asking for a borrower’s tax return can help prevent loan fraud, most institutions are actually trying to make sure they have a solid grasp of what someone’s actual income is. Typically, lenders are interested in things like determining if someone has employee business expenses that aren’t reimbursed and how much money is actually netted from rental property income.

Many people have 2106 business expenses, which are subtracted from an individual’s income; things that fall under this heading can include union dues, uniforms, mileage and marketing costs. These expenses can greatly increase someone’s apparent income. An applicant may report a yearly income of $100,000 but write off $20,000, resulting in an actual income of $80,000. This difference in income can prevent an applicant from qualifying for a loan.

Net rental property income is something else that a lender may be interested in. When aperson reports that they’re making $12,000 a year in income by renting out a home, a bank may want to find out how much of this is actual profit. If an individual is spending $10,000 annually on upkeep, property taxes and homeowner’s association dues, a lender will only consider an applicant to have $2,000 – not $12,000 – in rental income. Again, this disparity may prevent someone from qualifying for a home loan.

Tax Deductions Can Work Against You
It’s important to note that if a lender does ask you for your full tax returns, having a large number of write-offs could work against you. While it’s normal to want to reduce what you legally owe to the IRS, minimizing your apparent income can prevent you from being able to get a loan.

Unfortunately, the only solution for many people to qualify for a mortgage is to forgo tax deductions that they are entitled to for at least two years. Amending a tax return to adjust someone’s income can trigger a loan denial, which is why paying otherwise avoidable taxes is almost always necessary if someone’s income falls short due to deductions.

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