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