Evaluating and using Tax Returns for Mortgage Financing (Part One)

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Mortgage and Lending with Bank of Oregon a division of Willamette Valley Bank
https://activerain.com/droplet/Q2C

Evaluating and using Tax Returns for Mortgage Financing (Part One)

1040's

Chances are you have heard how the mortgage lending environment has changed and that it's becoming more challenging to obtain mortgage financing.  While that is certainly the case, there are still options out there.  In this Part One series, we will discuss how lenders analyze tax returns for mortgage financing.

 

 

Many self employed individuals or folks with complicated tax returns may be interested to know what mortgage lenders look for in those returns in order to establish qualifying income.  While different lenders may look at some situations differently, I hope this will help to explain some "basics" in terms of what is evaluated in those tax returns for mortgage financing, for qualifying purposes.

 

In Part One of this blog, let's look at how rental income is analyzed.For Rent

 

When using tax retuns for mortgage financing, the typical rule of thumb is that the lender will want two current, consecutive tax returns.  If the most recent tax year has not been completed yet, and an appropriate extension was filed, they may possibly allow an older tax year.  And I cannot stress enough, that lenders will want the full return, with all schedules, when using tax returns for mortgage financing.

 

So, let's say your Schedule E (The Federal Schedule used for reporting rental income) states that for the gross rents received on line 3 were say $24,000.  A potential borrower may be thinking to him or herself, 'heck, I can show that I make $24,000 per year in rental income".  Well not so fast.  Chances are you have expenses that you are writing off on this rental property, right?  Maybe things like management fees, cleaning costs, advertising, repairs, etc.  While all of those expenses are perfectly legitimate in terms of tax write offs, they will have an impact on what can be used in terms of income and in qualifying for your newly requested loan.

 

So here is somewhat of a simple example of how an underwriter will view rental income, as reported on those tax returns for mortgage financing.

 

Let's assume that for the two recent tax years, total rents received for each year were $24,000.  Let's also assume that in 2008 the Schedule E reflects $7,000 in misc. expenses and the 2009 Schedule E reflects $5,000 in misc. expenses.  Here is typically how an underwriter will determine eligible income.

calculator

Total Rents Received:     $48,000 (again, 424,000 for each year)

Less Expenses:            -  12,000  ($7,000 + $5,000 for 2008 and 2009 respectively)

Total Net Rental Income: $36,000

Divided by 24 mos:     =   $1,500 / mo  (again, we are using a 24 month dividing factor to determine a monthly figure, based on a two year period average).

 

So again, in this rather simplistic example of analyzing tax returns for mortgage financing, the underwriters would give you qualifying income of $1,500/month...NOT $2,000/month, as the borrower may have originally anticipated.  It should also be noted that lenders may allow any depreciation that was deducted to be added back in to eligible income and further noted, that it is not uncommon for lenders to only allow 75% of documented income to be used for qualifying purposes.  This reduction allows for any vacancy factors that a rental property could potentially be subject to.

Contact me today to get more details regarding tax returns for mortgage financing!

 

 

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karen burket

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Rainer
232,295
Sara Woolford & Steve Golson, ALHS
iTexas Realty Co. - San Antonio, TX

Hi Karen-

This is very well-written and gives one great example of why Buyers (or those looking to re-finance), need to be working with a plain-speaking professional so that they can understand not only the process, but the individual items that are so often unexplained in the qualifying process!

--Sara in San Antonio

Aug 04, 2011 06:37 AM #1
Rainer
143,002
Karen Burket
Bank of Oregon a division of Willamette Valley Bank - Medford, OR
Valley Mortgage Grou, Conventional, FHA, VA, mortgages

Hi Sara,

I'm glad you found the information helpful.  Thank you so much for your visit and your nice comments.  Greatly appreciated!  Have a great day.

Karen 

Aug 04, 2011 06:54 AM #2
Rainmaker
601,332
Donne Knudsen
Los Angeles & Ventura Counties in CA - Simi Valley, CA
CalState Realty Services

Karen - Excellent post!  This is such a misunderstood concept among self-employed borrowers.  This mentality often includes other types of additional income and write-offs they have and take too.  So many borrowers just don't seem to understand that once you choose to write off income, that income can typically no longer be used as qualifying income.  It's a never ending argument with some borrowers that most lenders use the AGI for qualifying purposes.

Aug 04, 2011 07:10 AM #3
Rainer
143,002
Karen Burket
Bank of Oregon a division of Willamette Valley Bank - Medford, OR
Valley Mortgage Grou, Conventional, FHA, VA, mortgages

Hi Donna!  Thanks so much for taking time to read and post.  It can be comical at times; a borrower "tells" you what he makes, but come to actually analyzing the returns produces a completely different story.  I do hope this information will help clarify for folks that don't understand.  Again, thanks for your comments and I wish you continued success!  

Aug 04, 2011 07:58 AM #4
Rainer
90,609
Maya Swamy
Funds Available - Long Beach, CA
Ph.D. Long Beach, CA - fundsavailable.com

So true and so clear. I have had would be buyers go backc and amend their taxes taking fewer deductions so that the income will qualify. It takes time and effort but sometimes that is the only way to qualify.

 

Aug 04, 2011 02:19 PM #5
Rainer
143,002
Karen Burket
Bank of Oregon a division of Willamette Valley Bank - Medford, OR
Valley Mortgage Grou, Conventional, FHA, VA, mortgages

Hi Maya!  I'd love some clarification from you regarding buyers to go back andamend their taxes.  Did they officially file amended returns? 

Aug 04, 2011 05:43 PM #6
Rainmaker
1,041,251
Charles McDonald
Charlottesville Real Estate Solutions - Charlottesville, VA
REALTORĀ®, Blogger, Principal BrokerĀ®, Owner

This is an excellent post. Hope you have a wonderful weekend

your friend in Charlottesville!

Aug 06, 2011 12:40 PM #7
Rainer
143,002
Karen Burket
Bank of Oregon a division of Willamette Valley Bank - Medford, OR
Valley Mortgage Grou, Conventional, FHA, VA, mortgages

Hi Charles!  Thank you for your visit and kind remarks.  Apologies in responding to you as we were out of town Friday - Monday and I'm just now logging back on.  Hope you have a terrific week!  :-)  Karen 

Aug 09, 2011 06:15 AM #8
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Rainer
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Karen Burket

Valley Mortgage Grou, Conventional, FHA, VA, mortgages
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