If you are self-employed or work on commission, be prepared to provide your lender with your tax returns. In addition, you’ll also have to provide your approval for them to request your tax transcripts. This is just a way for lenders to safeguard themselves against fraud. It gives them access to the returns you filed with the IRS. The lender looks to make sure the transcripts and the tax returns you provided match.
Why Tax Returns?
You might wonder why some people have to provide tax returns and others don’t. Basically, if you make money in any of the following ways, you’ll need to provide tax returns:
- Work for a close family member
- Make more than 25% of your income as commission
- Own rental properties which make you income
The only time you don’t need tax returns is when you work on an hourly or salary basis and receive W-2s. This income is straightforward and usually doesn’t have any unusual expenses that could take away from your income.
For example, a person working on commission may write off a variety of expenses in order to reduce the tax liability. If this is the case, the lender must use the net income you claim on your tax returns rather than the gross monthly income your paystubs show.
What Lenders Look for on a Transcript
When a lender requests your tax transcripts, they look for the following:
- Matching income to what you reported
- Matching income to the W-2s, or tax returns you provided
- Unreimbursed employee expenses that you claimed
- Self-employed business write-offs
- Are there a great deal of capital gains or losses?
- Is there a business loss?
The lender compares the tax transcripts to the documents you provided. If something doesn’t match, it raises a red flag and the lender may need more information or documentation from you.
Reasons Lenders Ask for Transcripts
Sometimes lender just order transcripts of your taxes no matter what. They don’t have a reason, they just check everyone’s.
Other times, they have specific reasons for doing so:
- Confirmation of an amount you owe to the IRS and determining if it’s paid off. If you owe money, it could change your debt ratio.
- Determine if you have any business losses that you did not report to the lender.
- Determine if you have any unreimbursed employee expenses that you did not report.
The tax transcripts give lenders backup proof that you could afford the loan they give you. Qualified Mortgage rules make this a necessity today. Even if the FHA doesn’t require the transcripts for each case, many lenders order them anyway.
The Qualified Mortgage Rules protect borrowers from getting loans they can’t afford. Lenders must prove beyond a reasonable doubt that you have the income to afford the loan. By looking at your transcripts, they can determine that your income is what it says it is.
Don’t be offended or surprised if a lender asks you for your permission to pull your tax transcripts. Oftentimes it is a part of the process. It’s a way for the lender to safeguard themselves against fraudulent applications. It also helps the lender make sure you can afford the loan and that they aren’t at risk for any type of default or liability.