Prior to approving a mortgage loan, most lenders require proof of a borrower’s income. Before the mortgage meltdown in the mid-2000s, many mortgage lenders offered stated income loans, which exchanged a higher interest rate for not requiring proof of income. Most mortgage investors eliminated these programs when the housing market collapsed. Since then, virtually every borrower who receives income other than a salary or hourly wage provides tax returns to document income. Even some of those who receive a salary or hourly wage must provide the tax returns prior to loan approval.
A borrower must provide the lender with tax returns anytime he receives income from self-employment, whether or not the income is used as a qualifier for the loan. Depending upon how you receive your self-employment income determines which types of tax returns are required. If you’re a sole proprietor or work under an LLC, you probably file a Schedule C with your tax returns. In this case, you would provide the lender with only your complete personal tax returns. If you have an S-corporation or a partnership, you likely file that income on a Schedule E. The lender may require complete personal and business tax returns including the K-1 issued to you by the company. Lenders require these tax documents as they are the best way to calculate your gross monthly income.
Many homeowners who own rental properties wish to use the rental income to qualify for a loan. Rental income is reported to the IRS using Schedule E for personal tax returns. Lenders often require two years of tax returns to document a two-year history of managing rental properties. Lenders also use the tax returns to calculate the monthly rental income that would offset the monthly mortgage payment.
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Un-Reimbursed Business Expenses
Some professions, such as salespeople and teachers, pay for some of their expenses out of their own pocket. The IRS allows deduction of un-reimbursed business expenses using Form 2106 and Schedule A. Mortgage lenders require the tax returns to calculate gross monthly income, which must be reduced by the amount of un-reimbursed business expenses.
Retired borrowers provide tax returns to document the receipt of their retirement income. Even if the borrowers only have Social Security, lenders require income tax returns. Social Security often is not taxable income. When this is the case, mortgage lenders gross up, or increase, the income by 125 percent to calculate rates. The tax returns are required to insure the Social Security income is not taxable before they gross up the income. These who receive income from pensions also require tax returns documenting receipt of the funds.
Mortgage lenders allow other types of income when qualifying a homeowner for a mortgage. Dividend and interest income and other passive income requires tax returns to document the history of receipt and the borrower's average monthly income. With these income types, lenders often require more than just the tax returns because the borrowers must be able to prove the income will continue for three years.