Your tax returns say a lot about your income. When you use your returns to verify your income for a mortgage, there is a lot more to it than just looking at your tax forms. Mortgage companies must fully evaluate your income. This often causes tax return issues that either delay your approval or eliminate it altogether.
If you are self-employed or make more than 25% of your income in commission, you must provide your tax returns for income verification. This means the lender will also order your tax transcripts. This is to ensure the documents you provided to the lender are real. If the tax transcripts do not match the tax returns you provided the lender, it can cause a delay in your mortgage processing. The lender needs to determine where the differences are and if they were intentional. Some of the issues that can arise include:
- No tax transcripts exist, which means you never filed them in the first place. This would render you ineligible for a loan because you participated in fraudulent activity. The lender has no way to prove whether you changed the returns you provided them with or if you ever intended to file them.
- Your transcripts have a different bottom line than the returns you gave the lender. This means you changed something on the returns you provided to the lender. If you did this intentionally, you could lose your mortgage approval.
Tax debt does not always preclude you from obtaining a mortgage, but in some cases, it may. If you owe money to the IRS and you avoided paying it, you have an outstanding debt. There are a few ways to handle this:
- If you own a home, the IRS may put a lien on it for the tax debt. No mortgage company will fund a new loan for you until you pay the lien in full.
- If you don’t own a home, you won’t have a lien on any property, but you still owe the IRS. The lender needs to include the debt in your debt ratio. If you are beyond the point of an installment payment plan, this could inflate your debt ratio too much for approval.
- If you have several years of unpaid tax payments, it shows the lender that you are irresponsible with your debts. A federal debt cannot be overlooked, which means you would likely be without a mortgage approval.
Discrepancy with Income
If you own your own business or work as a commissioned employee, the lender must use the money you claim on your tax return. If you write off many expenses, this may lower your qualifying income. Even if you only claim the expenses to lower your tax debt, which is legal, the mortgage company must use this amount. This means if you show a loss for your business, you may not qualify for the loan. The lender must use the official tax documents over your bank statements or any other proof of income you can provide.
The same issues arise with unreimbursed employee expenses. If you work for someone, but your income is more than 25% commission based, you can write off certain employee expenses. Again, this is a legal deduction; however, it lowers your qualifying income for a mortgage.
Getting Around Tax Return Issues
Just because you have tax return issues, it does not automatically leave you without a mortgage approval. There are some ways to fix it including:
- File your tax returns, including the overdue returns. Once you properly file your taxes and the IRS has tax transcripts available, you may be able to apply for a mortgage.
- Provide honest copies of your tax returns. Don’t change numbers to inflate your income or decrease your costs. The lender will find out what you really filed with the tax transcripts. You could be accused of tax fraud if you change anything for the sake of approval.
- Pay your tax payments on time. If you cannot afford the full debt, create an installment payment plan with the IRS. As long as you make the payments on time, most lenders will include it in your debt ratio. As long as your debt ratio is not too high, you can gain mortgage approval.
- Watch how many expenses you write off. You need to do this in the years leading up to your mortgage application. This requires planning. Once you close on your mortgage, you are free to write off the business or unreimbursed employee expenses again. You just need the higher income for mortgage approval purposes.
As you can see, your tax returns play a crucial role in your mortgage approval. Not all tax return issues mean an immediate mortgage denial either. As long as you are honest with your lender and the IRS, you can overcome most issues. If it is a debt ratio issue or a lien on your home, you will have to work to pay the debt down or off. All other issues, however, are avoidable, as long as you provide honest tax returns with your lender. Don’t avoid filing your taxes, even if you cannot pay right away. In most cases, the IRS will grant you a payment plan. This enables you to secure other types of financing in the future. Unpaid federal or state taxes can only hurt you in the end.