Do Mortgage Lenders Look at Tax Returns? What You Need to Know
Learn how mortgage lenders use tax returns to assess income stability, verify earnings, and ensure financial consistency during the loan approval process.
Mortgage lenders evaluate financial documents to determine whether a borrower can afford a loan. One key document they may request is tax returns, which provide a detailed record of income and financial history. While not always required, tax filings are especially important for certain borrowers.
Understanding why lenders review tax returns and what details they examine can help you prepare for the mortgage application process.
Why Some Lenders Require Tax Filings
Lenders request tax returns to verify financial details not fully captured in pay stubs or bank statements. Unlike other documents, tax filings provide a multi-year record of income, deductions, and financial obligations. This helps confirm that reported earnings match IRS records, reducing the risk of fraud.
Tax returns also reveal financial responsibility. A history of unfiled or late tax returns can signal poor financial management, while outstanding tax liabilities, especially tax liens, are red flags since they take priority over mortgage debt in a default.
For borrowers with multiple income streams, tax returns clarify earnings consistency. Rental income, dividends, and capital gains are all reported, helping lenders assess financial stability. If a borrower claims significant deductions or losses, lenders may adjust their assessment of available income, which can impact loan approval.
Assessing Income Stability
Lenders use tax returns to evaluate whether a borrower’s income is steady enough to support mortgage payments. A consistent earnings pattern over multiple years reassures lenders of reliability. Adjusted gross income (AGI) is key, reflecting total earnings after deductions. If income fluctuates, lenders may average earnings over two or more years to gauge stability.
Employment history also matters. Borrowers with at least two years of stable income in the same field are viewed as lower risk. Frequent job changes or employment gaps introduce uncertainty. If an applicant recently changed jobs but remains in the same industry, lenders may request an employment contract or offer letter to confirm continued earning potential.
Income composition is another factor. Borrowers relying on commissions, bonuses, or seasonal work face additional scrutiny. Lenders often discount these sources to account for variability. For instance, if a borrower earns significant overtime pay, only a portion may be considered unless there is a documented history of consistent overtime earnings. Similarly, if an applicant receives alimony or child support, lenders may require proof that these payments will continue for several years before counting them as qualifying income.
Reviewing Self-Employment Earnings
Self-employed borrowers face additional scrutiny since they do not receive W-2 wages. Lenders focus on taxable income rather than gross revenue, as business deductions can significantly reduce the amount considered for loan qualification. If a borrower aggressively writes off expenses, their reported income may appear lower, affecting loan eligibility.
Lenders examine Schedule C (for sole proprietors) or Schedule K-1 (for partnerships and S corporations) to evaluate business profitability. A history of declining profits or frequent losses can raise concerns about long-term viability. If a borrower operates through a corporation, lenders may also review corporate tax returns (Form 1120 or 1120S) to assess retained earnings and cash flow.
To verify reported income, lenders often request IRS tax transcripts to ensure tax returns match IRS filings. If the most recent tax return is over a year old, lenders may also require a year-to-date profit and loss statement to confirm income trends remain stable.
Evaluating Additional Sources of Revenue
Many borrowers earn income beyond traditional employment, and lenders assess these alternative revenue streams carefully. Investment income, such as dividends from stocks, interest from bonds, and mutual fund distributions, is considered if there is a history of consistent returns. IRS Form 1099-DIV and Form 1099-INT document these earnings, while brokerage statements help verify asset stability.
Rental income is another key factor, especially for borrowers with multiple properties. Lenders typically apply a vacancy factor, often around 25%, to account for potential periods without tenants. Schedule E of a tax return outlines rental revenue and expenses like property taxes, depreciation, and maintenance costs, all of which impact net income calculations. If a borrower recently acquired a rental property, lenders may request a lease agreement and proof of rental deposits to verify income legitimacy.
Considering Consistency With Other Financial Records
Lenders compare tax returns with other financial documents to ensure accuracy. Discrepancies between reported income on tax filings and figures listed on bank statements, pay stubs, or profit and loss statements can raise concerns. If a borrower claims a higher income on a mortgage application than what is reflected in their tax returns, lenders may request additional documentation. Large unexplained bank deposits that do not align with reported earnings can also prompt further scrutiny.
Debt obligations and deductions reported on tax filings are cross-referenced with credit reports and other financial statements. If a borrower has significant business expenses or liabilities not reflected elsewhere, lenders may adjust their assessment of financial capacity. Tax returns can also reveal obligations such as alimony or student loan interest deductions, which lenders factor into debt-to-income (DTI) calculations. Ensuring all financial records align helps prevent delays in the mortgage approval process and reduces the likelihood of additional verification requests.