What Do Mortgage Lenders Look for On Tax Returns?

Written by Banks Editorial Team
4 min. read
Written by Banks Editorial Team
4 min. read

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Buying your home is probably one of the biggest purchases of a lifetime. And if you’re like many Americans who finance their home purchase, you’ll go through the mortgage application process. While qualifying for a mortgage loan isn’t hard, it can be a tiresome process as it requires a bunch of documentation.

The goal for the majority of the mortgage lenders is to prove your ability to repay the loan. Therefore, every time you apply for a home loan, your lender will likely ask you to provide your income documentation, which can include recent pay stubs, W-2s, and one to two years’ tax returns.

So, what do mortgage lenders look for on tax returns? Keep reading to find out.

Traditional and NQ Mortgage Loans

 
Are you looking to finance a home too expensive for a conventional loan? An Angel Oak Jumbo Loan can provide financing for up to $3.5 million.

Understanding Tax Returns

Whether you’re employed, self-employed, or a 1099 earner, you may need to provide copies of your tax returns.

Employees

If you’re an employee of a company who receives paystubs and W-2s from your employer, prepare at least two years’ tax returns since your mortgage lender will need recent copies. It’s also important to note that your underwriter may check your tax transcripts from the Internal Revenue Service (IRS) to ensure that the information matches your W-2s. 

If you also have other sources of income, such as retirement or rental property income, examining your tax returns will also help verify this income. Underwriters will then use the income information in your tax returns to determine whether you qualify for a mortgage or not.

Self-Employed

Getting a mortgage as a self-employed borrower can be more challenging than if you were an employee of a company. This is because you don’t have pay stubs or W-2s that mortgage underwriters use to verify income. Plus, tax write-offs reduce the amount of income that the mortgage underwriter could consider as income.

Self-employment income tends to fluctuate from time to time, and lenders typically view self-employed individuals as “high-risk borrowers.” As a result, lenders may request alternative documentation, such as your bank statements and liquid assets as proof of income.

1099 Earners

1099 earners are considered “self-employed” too. These workers can be freelancers, independent contractors, or other self-employed individuals completing particular assignments. 1099 earners also don’t have tax returns, and it may be harder to qualify for a mortgage loan.

Why Mortgage Lenders Need Tax Returns

Mortgage lenders ask for your tax returns to verify your income. Tax documents give lenders information about your sources of income and possibly help them determine how much mortgage you’re eligible for. In addition, since a mortgage commits to years of payments, they want to determine your ability to repay your mortgage without falling behind or defaulting.

The lender will often ask for up to two years’ worth of personal tax returns or business tax returns (if you’re a business owner) to see if you have a steady income flowing in each month. 

Depending on what your lender will find on your tax returns, they may request additional information, such as a profit and loss statement or bank statement if you’re self-employed.

Traditional and NQ Mortgage Loans

 
Are you looking to finance a home too expensive for a conventional loan? An Angel Oak Jumbo Loan can provide financing for up to $3.5 million.

Can You Get a Mortgage Loan Using Just Your Tax Returns?

Yes, that’s very possible. After all, your tax returns state your sources of income. So, lenders will use your tax documents to verify your monthly income. It will also help lenders determine how much mortgage you can qualify for.

What Do Mortgage Lenders Look for on Tax Returns?

Here are the things most mortgage lenders look for on your tax returns.

Your Income and Assets

The most obvious aspect lenders look at when reviewing tax returns is verifying income. This is arguably the most critical step in the underwriting process. Your tax documentation will give lenders an overview of your monthly gross income over a given period of time. 

Tax returns will also show the number of assets you own. Lenders will need to see your business tax returns if you’re a small business owner.

Income Stability

Lenders will also look at the stability of your income over a given period, typically two years. They’ll want to see a steady gross monthly income and that it will remain the same through the loan term. This way, mortgage loan lenders can ensure that you’ll be able to repay the loan down the road.

If lenders see a change in trend to the downside or other fluctuations in your income, they might request additional information. 

Your Level of Risk as a Borrower

Another thing that lenders look at is your level of risk as a borrower. You can appear a high-risk borrower if your credit scores are too low and your debt-to-income ratio is too high. Therefore, you may want to work on improving your credit score and lowering your DTI ratio before submitting your loan application.

Your Ability to Repay

Lenders are more reluctant to loan to mortgage borrowers who don’t have the ability to pay back the borrowed amount. Your income shows whether you can manage your monthly payments without defaulting, so make sure you have your income documentation.

Debt-to-income Ratio

Lenders use our debt-to-income (DTI) to evaluate your ability to manage your monthly mortgage payments in addition to your other debt responsibilities without difficulty. It’s often expressed as a percentage. The higher your DTI ratio, the riskier you appear to lenders. 

As a general rule of thumb, your DTI ratio should be lower than 43%. However, lenders prefer DTI ratios lower than 36% because it shows you’re unlikely to default on your loan.

Your Character

Tax returns may also reveal your character and your mental and moral traits. Mortgage lenders want to loan money to responsible borrowers with good character. This can be displayed in various ways. For one, lenders will review if you’ve ever missed filing your federal tax returns. If so, this may negatively impact your character with that of the SBA.

Any Red Flags

Apart from the abovementioned things, lenders will also look for any red flags. Potential red flags can include incomplete income documentation, no license to prove business ownership, and more.

Where Can You Use Your Tax Returns to Get a Home Loan?

Mortgage brokers often work with lenders, and you may get a lender through them. But if you don’t want to pay broker fees, consider online lenders like Angel Oak Home Loans offer several mortgage products that you can get using your tax returns. These loan products include:

Are you ready to turn your dream of homeownership into a reality? Then, submit a simple online form to find out more about the home loan you can get using your tax returns.

Angel Oak

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