Mortgage calculators and the 1-2-3 of qualifying your tax returns

September 22nd, 2010

How familiar are you with your income tax return? Do you have 2106 expenses or a Schedule E? You are using mortgage calculators to research a refinance mortgage or new home loan, are you sure you are using the correct income for qualifying? Increasingly what is on your tax returns impacts the income used by lenders for qualifying. Here are three points you need to know if you are using a prequalification calculator for a new home loan or other mortgage calculators to take advantage of historically low mortgage rates.

1) Don’t overlook business expenses

On almost every mortgage application that is being underwritten today lenders are requiring borrowers sign IRS Form 4506, or 4506-T. Form 4506 gives the lender the authorization to obtain a copy of the tax returns you have filed in previous years. Why are they doing this? To see if you have additional expenses that are work related, own other property or have some additional liabilities that you are not reporting on your mortgage application.

While you may be inputting your salary for a prequalification calculator, lenders are checking to be sure that there is not more to the story of your income or liabilities than what is shown on your application. Many tax payers have write-offs on their tax returns they may not be fully aware of. A primary example is the use of unreimbursed business expenses, also known as 2106 expenses. You may have expenses on form 2106 for business use of your car, uniforms, mobile phone, meals, travel etc. that you deduct from your income and do not consider when completing your mortgage application. Underwriters will deduct these expenses from your income, therefore it is prudent your mortgage originator is aware of them up front.

2) The two-year rule

Any expense or income that shows on your tax returns for two consecutive years needs to be calculated for underwriting. For income the rule of thumb is the lesser of a two-year average or the most recent income tax return will be used for qualifying. As an example, if your 2008 return showed your self-employed income on Schedule C was $72,000 and your income for 2009 was $74,000 the two years would be averaged to an annual income of $73,000. If, however, your 2009 income was $68,000 the underwriter will not average 2008 and 2009, but rather consider your annual income to be $68,000.

Likewise, with expenses, a two-year average is generally used; however if you have an expense in 2009 that did not show in 2008, unless you can prove it was a one-time expense the underwriter will usually subtract it from your income.

If you have any additional income from trusts, S Corporations, rental property, etc. be sure to use the two-year rule for calculating income for prequalification calculators.

3. Depreciation can add to income

It is not all doom and gloom and reduced income that results from tax returns. If you have a business for which you file a Schedule C or own investment property and file a Schedule E you can add back any depreciation you have claimed. Depending on your business this can be a significant number that assists your qualifying. If your prior year tax returns have a one-time investment loss that you can prove was one time, that deduction would not be applied to current income calculations.

Mortgage calculators only use what you type in. To have the most accurate results it is best to input the most accurate numbers for income and expenses. Knowing your tax returns will most likely be scrutinized by your lender it is suggested you take a look at your returns yourself to see if there are any changes that may be made that impact your income qualification for your mortgage refinance or new home loan. Even though mortgage rates are at all-time lows your income matters in order to qualify for that historically low mortgage rate.

Posted By :
Dennis C. Smith is co-owner and broker of record for Stratis Financial in southern California. He has over twenty years' experience in the mortgage industry.

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