Mortgage and Portfolio Loan Guide

Tax Returns and Mortgage Approval

What impact do your tax returns have on buying a house?

It is no secret that the income piece of the mortgage approval process is a major factor. Your ability to repay the mortgage is arguably to MOST important factor that is considered when applying for a home loan.

But how is that income calculated?

What if you are self-employed?

What if you have multiple sources of income?

In this post I am going to cover some of the most important things to consider when it comes to buying a house, and how your income plays such a major role.

How is my income calculated on my mortgage application?

There are many different forms of income, I am going to cover the most common that I run into, and give you general basics on how that income is considered in connection with mortgage appproval.

No matter the scenario, an underwriter is going to want to see consistency, and stability. Proving your ability to repay is the name of the game. If you can demonstrate consistency over most recent 24 months, and stability (same line of work), you are on the right track.

Salary employee (W-2)tax returns mortgage approval

Your annual gross salary divided by 12.

Example: 120,000 annual salary / 12 = 10,000 monthly income

For salaried employees it’s pretty straight forward as long as you have been in the same industry for 2 years. If you used to be an electrical engineer at 100K/year, but now you teach physical education at the elementary school, the underwriter may ask questions regarding stability, and may need to you to be on the job for 6-12 months before reconsidering.

It has to make sense.

Hourly Employee

Base wage is calculated by average number of hours reflected on most recent 30 days pay stubs.

Example: $15/hour X 40 hours per week X 52 / 12 = 2,600/month

If number of hours fluctuate, you’ll need a written verification of income ordered by your lender to be filled out by your boss or human resources department in order to get a better feel for your average number of hours worked

Commission – Bonus – Incentive – Overtime Income

Any fluctuating income is going to require a 24 month history in order to calculate consistency. If the incentive income is declining the underwriter will likely only use the most recent 12 months or year to date amount for the commission/bonus/overtime income in order to be safe.

1099 – Private Contractor Income

When you are a 1099 employee, the company paying you does not deduct things like federal/state income tax from your gross income. For that reason, what you claim on your federal tax returns as your actual income is up in the air until you actually file your tax returns.

There may be deductions that you’re eligible for that will reduce the amount of income you claim on your tax returns.

That reduction in earnings claimed will have an impact on your debt to income ratio when applying for a mortgage.

There is almost always a lack of consistency when considering 1099 income because of the nature of those types of earnings.

Again, in this case the underwriter is going to want to see proof of 24 months of receiving that type of income in order to determine what you actually claim as income after tax write-offs.

Self-Employed Income – Business Owners

Self-employed income is evaluated similar to the way 1099 employee income is reviewed.bank statement loan program

Always best to be able to show two full years of tax returns so that the underwriter can reasonably calculate your income, and get a feel for the health of the business.

For simplicity purposes: your income is the number that is shown on the Adjusted Gross Income line on page 1 of the 1040’s.

Yes there are some deductions that can be added back into the bottom line, but for starters – just find the adjusted gross income to understand basic ballpark.

In addition it is common to have to require a year to date profit and loss statement. This is used to evaluate how the company is doing in comparison to the previous year. It is NOT used to increase your income if you happen to be having a very strong year.

If your business is anything OTHER than LLC or sole proprietorship, you’ll also need to provide two years of business/corporate tax returns along with K-1 if applicable.

Multiple Sources of Income

When seeking approval with 2 jobs, you need to be on job jobs for two full years. Otherwise there is no way to determine the likelihood of you being able to maintain that type of demanding work load.

If the second source of income is NOT from an employer, requirements will vary depending on source of income (disability, social security, pension, rental income, etc.).

Keep in mind – the name of the game is the ability to prove consistency and stability.

What if I filed an extension on my tax returns?

Many business owners take advantage of the opportunity to NOT file their taxes in April like the rest of the country, and instead file an “extension”. The extension allows them to not officially file their taxes until October.

This presents challenges when applying for a mortgage for 2 major reasons:

  1. The income for the year that the extension is filed for is basically disregarded by the underwriter. They will only consider it to confirm the income is in line with previous years. Cannot use it to increase the averages.
  2. When the extension is filed, there is an estimated amount owed for that year’s taxes. When an underwriter sees that estimated amount owed on the extension, they will typically require that amount to be paid prior to closing.

This goes for personal and business tax returns alike.

What if I show low income on my tax returns and I am a business owner?

It is very common for business owners to take full advantage of the legal tax write-offs that are available to them.

The problem with using those write-offs is they often offset the bottom line income claimed significantly.

For business owners in this scenario, who actually have strong income that they can prove – a bank statement loan may be the best solution.

A bank statement loan is a type of portfolio loan that allows business owners to qualify based on the income shown on their bank statements over a 12-24 month period.

This gives the lender the opportunity to evaluate a self-employed borrower’s income with more of a common sense approach.

On a bank statement loan you must be self-employed with the same business for at least two years.

[more on Bank Statement Loans and Portfolio Loans here]

What if I have been self-employed for less than two years?

If you have have been self-employed less than 2 years you may need to look into getting a portfolio loan.

It’s an underwriter call, but without having 2 full years tax returns as self-employed most underwriters find it difficult to agree that stability has been established.

With a portfolio loan you may be able to get around that requirement if:

  • You have been self-employed for at least 1 full year on tax returns
  • You have at least two years of documented previous successful employment in the line of work in which you are self-employed in, or in a related occupation or
  • You have one year of employment and formal education or training in the same line of work

If you’re in business less than one year, that income is not going to be considered as effective.

What if I want to only use my most recent year tax return to qualify?

When having a strong rebounding year after a slow year, it is often asked if a business owner can ONLY use the most recent year tax return to qualify. The logic is to be able to exclude the need to average the low year with the most recent strong year.

There is a conventional product that will allow you to use only the most recent year’s tax returns to qualify.

To be eligible for this product, you must have been in business for at least 5 years, and meet all other credit and asset guidelines. Contact me for questions on this.

In Summary

Tax returns play an extremely important role in the home buying process.

When you file, how you file, and how much income you claim will determine what type of loan will suit you best.

Get your questions answered.

 

I encourage you to reach out.

We can’t help everyone, but we do make every effort to take a common sense approach to get our borrowers approved if it makes sense.

 

 

 

self employed home loans

Self-Employed Less Than Two Years Mortgage Solution

Update: 3/6/17

No conforming product currently allows for 1 year tax returns as self-employed if self-employed less than 2 years. On a vary rare basis, some lenders will allow for less than 2 years self-employment. 

It is unclear currently on if 2 year tax returns averaged will be acceptable. 

I will keep this updated as new information comes in. The updated guideline is below. -Adam Lesner

For self-employed Borrowers, the number of years of required tax returns will be based on the number of years the business has been in existence:

  • For businesses operating for five or more (5+) years, one (1) year of business and personal returns will be required.
  • For businesses operating for less than five (5) years, two (2) years of business and personal returns will be required.

(the solution may be a portfolio loan if you have extensive experience in same line of work prior to going self-employed and have at least 1 full year tax return as self-employed)

Is it possible to buy a home if you are a “private contractor” or have been self-employed less than 2 years?

The answer is yes it’s possible, but each situation is unique.

Before we dive into how it’s possible, let’s get on the same page of what the root issue is. Being self-employed less than two years makes it difficult for the lender to make a determination of what your actual income is because there is limited history. Since there is limited history, it’s just as difficult to determine the likelihood of that income to continue in the future.

“Okay, but Adam, I can show you my bank statements with deposits of $10,000/week.”

Right, I get it. You make good money. You have cash money sitting in your bank as a result of your business being profitable. The problem: the lender can’t see how much you had to spend in order to get that kind of return unless you have a profit and loss statement prepared, and show proof of how you’re reporting those expenses to Uncle Sam.  So many, maybe even 80% of the business owners that provide tax returns for me to look at, claim substantial write-offs which offset their income in a way that nearly puts them at a break-even point. The solution: get a bank statement mortgage. There are a few different options when it comes to using bank statements as proof of income. Ask me if I can help with your unique situation by using you bank statements as proof of income.

The good news…

person-110303_1280is that there are lenders out there that will take a look at self-employed borrowers, or even 1099 private contractors from a common sense standpoint. Standard loans backed by Fannie Mae, Freddie Mac, FHA, etc. are not going to be the way to go if you’re self-employed less than two years. The guidelines are strict, and the opportunity to be looked at from a common sense standpoint are extremely limited. Your best bet is to find a lender that offers portfolio financing. This is where they lend their own money, and keep your loan in-house. Keeping your loan in-house means it will not be sold on the secondary market, which means it will not have to meet the strict guidelines of conventional and FHA mortgages. You’ll find portfolio lending with the smaller lenders or credit unions in your local areas. They are the companies that are organically grown within the community, and they tend to have more of an attachment to the area.

2 examples that might make sense to get approved for home financing for less than two years self-employed borrowers:

  1. You have been an IT professional for 5 years. Last year you went from being a W-2 employee to a 1099 employee (private contractor). You’re still working for the same company, but now you are on an annual contract instead of an annual salary. You provide a profit and loss statement showing your income is consistent with how you claimed your tax returns last year. Bam! It makes sense right? Well, most lenders won’t talk to you unless you have 2 years tax returns.
  2. You have been in business for yourself for 5 years running a printer supply store. Last year you had to change the name of your company because of a shady partner that you had to break ties with. You still operate on the same premises. The only thing that changed is the name of your company. Some loan officers will say “Yeah, let’s do this,” just to find out a week before closing that their underwriter isn’t going to approve the loan because there is not a two year history of that business. But, come on, it’s common sense. You’re only going to be looked at from a common sense standpoint in a case like this if you’re working with a lender that offers portfolio loans.

An example that probably won’t fly:

  • You have been a plumber for 10 years. You decide to quit your job and open a pizza parlor. You decide 6 months into it that you want to buy your dream home on the lake. Sorry, it’s going to be impossible to make a determination of what your income is in that short period of time.

How do tax returns impact your mortgage approval? Here is my latest post on that.

 

 



When seeking a portfolio loan, keep these things in mind…check-37583_1280

These are loans that are funded in-house with your particular lender, taking risks the vast majority of lenders aren’t willing to take. You may be required to put 10% down or more. You may only be able to do this type of loan on a primary residence. Your rate might not be the same as what conventional rates are. You may get a chance to be told “Yup, you’re approved”, when everyone else is saying “no”!

I invite you to reach out to me.

portfolio mortgage lendersGet your questions answered. You will not be talking with an intern, or someone who just got their mortgage license. You’ll be talking with me directly.

We can’t help everyone, but we do make every effort to take a common sense approach to get self-employed borrowers approved if it makes sense.

pre approved home loan

 

How Much Home Can You Afford?

What Mortgage Can I Afford?

So let me get this straight; you make $300,000 annually, but you show Uncle Sam that your income is below the poverty line? Sure, no problem, let’s get you that 2nd home on the beach!

Yes that example may be a little extreme. However, this is something that constantly comes up with potential homeowners. In Part 3 of the “keeping your home loan process simple” series; the income piece of the mortgage puzzle is laid out in plain text.

Here is the short of it: Show a recent 2 year consistent income on your tax returns, and prove you’re still receiving that compensation. There you go, no need to keep reading, unless of course your circumstances aren’t quite that simple.

The truth is that even if you’re a salaried employee with a fortune 500 company; in some cases it can still be a challenge to prove your income, and how you’re compensated. This should help you answer the question “what mortgage can I afford”.

Income basics

If you’re employed you can be sure you’ll be asked for the following: Most recent 2 years federal tax returns (all pages), mostBrighton, MI

recent 2 years W-2s (1099’s if applicable), and most recent 30 days worth of pay stubs. You may not always be asked for your tax returns, but it’s best to provide them up front in order to reduce any last minute surprises.

  • Pay stubs should show: the same employers name or entity as the W-2, your name, taxes withheld, and pay rate.
  • If you are using overtime, bonus, or special incentive pay to qualify your employer will need to break down that pay separate from your salary (or hourly) pay. They will also need to confirm in writing how much of that type of income you have received in the last 2 years, and how much you’ve received so far in the present year. This helps the lender to gain an understanding of how consistent, and stable that income has been for you historically.
  • For commission income you’ll need to provide a 2 year history as well. Additionally, your tax returns will get examined in more detail to confirm you didn’t have any employment writeoffs which may offset your income. This can be more common with commission folks.
  • Your lender will order your tax transcripts from the IRS. The purpose is to verify that the IRS shows the same figures as the tax returns you provided.

Self-employed

If you have ownership interest in a company you’ll need to provide at least 2 years most recent federal tax returns (all pages). If you file business tax returns be ready to provide those as well. Your accountant will need to provide a P&L (profit and loss statement) if you happen to be applying for a home loan in the month of April or later in the year. Your P&L states how the company is performing for the year so far. Your P&L gives the lender a picture of how your income (or loss) looks in comparison to previous years. Again, your lender is looking for stability and consistency (or lack there of).

Debt-to-income ratio

michigan mortgage lenderYour monthly liabilities divided by your monthly verifiable income equals your debt-to-income ratio. The liabilities that are considered in this figure are the payments shown on your credit report, property insurance/taxes, alimony/child support owed, and any other legally binding payment. It’s best to do what you can to put yourself in a position to be at or below 43% debt-to-income ratio.Example… Mr. Homeowner has a car loan and credit card; combined payments are $250/month. His mortgage payment including taxes, insurance, and mortgage insurance is $1,100/month. Mr. Homeowner is an engineer with a $60,000/year salary. Mr. Homeowner’s debt-to-income ratio looks like this: 1,350 / 5,000 = .27, or 27%.

Beyond basics

Rental property – 2 years most recent federal tax returns, proof of property taxes and homeowners insurance. Your credit report will show your mortgage payment. If you have your taxes and insurance escrowed (included with the monthly payment) provide your mortgage statement.

Investment income and capital gains – 2 years most recent federal tax returns. Your lender will evaluate consistency, and likelihood of continuance.

Alimony/Child support – You’re probably shocked, but some ex-spouses fail to pay court ordered alimony or child support. For that reason you’ll need to show proof you have been receiving consistent payments for at least 6 months. Also have the full divorce decree ready, and any other updated court documents addressing any changes.

Social security retirement – Current year award letter from social security which states the amount of monthly compensation you’re entitled to. Also a good idea to provide 2 months bank statements showing the deposits received from social security.

Social security permanent disability – If social security has deemed you to be permanently disabled you will have an award letter confirming such compensation. You may also be required to provide a recent letter from a physician confirmingmichigan mortgage lender the state of your condition and the likelihood of the condition to change.

Short term disability – Short term disability will be most likely ineligible to use to qualify for a mortgage because of the uncertainty of continuance.

Pension/retirement – Some pension plans will provide a pay stub and W-2; similar to what you received when you were working. If so, that should be simple enough to verify. If you’re receiving income from an annuity, IRA, or 401K you’ll need to prove it. It would be a good idea to have your most recent quarterly investment statement handy; along with 2 years tax returns. The investment statement you provide will help track your draw (income) history, but also give an indication as to how long that income is likely to continue. The remaining balance should be at least enough to sustain the same draws for 3 years.

VA disability – After being discharged from the armed forces; a veteran may be entitled to disability compensation for injuries sustained while in service. Similar to social security disability; you’ll have an award letter issued to you stating your compensation benefits. The VA has gotten much better in the last few years on requests for a new letter or verification of the status. More on VA and veteran benefits coming soon.

Unemployment – Typically, if unemployment is reported on your tax returns you’ll need to explain in writing why you were receiving unemployment. If you’re in a seasonal line of work like landscaping, and you cannot work in the winter, that would be considered reasonable reason to consider using unemployment income to qualify. If you lost your job and couldn’t find employment for a year; the unemployment compensation you received at that time wouldn’t be considered as stable.

Part time – You must demonstrate a 2 year history receiving consistent hours and pay.

Higher education – You can use the time spent while in college or trade school as part of your 2 year history. The time in higher learning will be considered if you can provide transcripts or a diploma. If school is part of your 2 year history; the only income considered for your new employment will be salary/hourly income in a full time position.

Under the table – Waiters and bartenders tend to not claim all tips received on their tax returns. Any job that you have that is paid under the table will not be considered.

Letters of explanation – When your situation is unique, and you have an opportunity to tell the story, take that opportunity seriously. Be detailed in why it took 4 months to find a job, or why your relocation to another state will not have a negative impact on your income. You’re painting a picture for your lender. You’re helping them put together the puzzle.

Verification of employment – Your lender will reach out to your employer to make sure you actually work there. While your loan is in process, and right before closing your loan your employment status will be verified. This is also an opportunity to have your commission, bonus, or overtime income verified. Things can get sticky if your employer refuses to break down your salary income from other compensation in detail.

What’s the name of the game? If you said consistency coupled with stability; you’d be dead on. Of course the ability to provide relevant documentation to support everything puts the icing on the cake.

A few tips to end with for now…

Your tax returns show unreimbursed business expenses on you schedule A. Take a look at those before you turn your tax returns in to your lender even if you’re not a business owner. A mechanic at a dealership could claim unreimbursed expenses for uniform costs throughout the year. Often times unreimbursed business expenses can cause a last minute issue if they are initially overlooked. Claiming that type of write-off could have an impact on your debt-to-income ratio.

If you have taken out a 401K loan against your employer’s retirement plan there will be an item on your paystub that with address that. Since it’s a loan you’re paying back, that liability would have to be considered in your debt-to-income ratio. If your total vested balance in the 401K exceeds the amount of the loan you have against it; you may be able to exclude that liability from your debt ratio. Have your most recent quarterly statement handy to show your balance.

Having the last pay stub (December 31st pay stub) for the previous two years will often be an easy way to verify how much bonus, commission, and overtime income you received in the previous years.

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