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 review financial documents to determine if a borrower can repay a loan. While pay stubs and bank statements provide insight, tax returns offer a more complete financial picture.
Understanding why lenders request tax filings helps borrowers prepare for the mortgage application process.
Why Some Lenders Require Tax Filings
Lenders use tax returns to verify income and ensure it aligns with official records. Unlike pay stubs or bank statements, tax filings provide a comprehensive view of earnings, deductions, and liabilities. IRS Form 1040, along with schedules like Schedule C for self-employed individuals or Schedule E for rental income, reveals total income and potential financial risks.
Large deductions or major fluctuations in reported earnings may indicate instability. For example, significant business losses on Schedule C could suggest financial strain. Discrepancies between tax filings and other financial documents may also raise concerns about misrepresentation.
Lenders check for outstanding tax obligations, as unpaid taxes can impact mortgage payments. IRS tax liens, which are public records, may complicate loan approval. In such cases, lenders often require proof of a repayment plan or full payment before proceeding.
Assessing Income Stability
A steady earnings pattern reassures lenders that a borrower can manage long-term mortgage payments. Consistent employment history, wage growth, and minimal job changes are favorable indicators. Regular salary increases or promotions suggest financial progression.
Employment tenure matters. Lenders typically prefer applicants with at least two years at the same job. Frequent job changes can signal instability, though staying within the same industry or moving to a higher-paying role may still be viewed positively. Those with employment gaps may need to provide additional documentation, such as an offer letter, to demonstrate stability.
Bonuses, commissions, and overtime earnings receive extra scrutiny. Lenders usually require a two-year history to include these in qualifying income. If past bonuses were large but inconsistent, only a portion—or none—may be considered. This is especially relevant in industries with variable pay structures.
Reviewing Self-Employment Earnings
Self-employed borrowers face stricter income verification than those with traditional wages. Lenders focus on net profit rather than gross earnings, as business deductions reduce taxable income. High deductions for expenses like vehicles, home offices, or depreciation can lower the income considered for loan approval.
Lenders review IRS Form 1040 along with Schedule C for sole proprietors or Schedule K-1 for partnerships and S corporations. If business profits fluctuate, income may be averaged over two years. However, if earnings decline year over year, only the most recent, lower figure may be used. Borrowers who retain earnings within a business may need additional documentation, such as profit and loss statements, to confirm available funds.
Evaluating Additional Sources of Revenue
Lenders assess supplementary income to determine a borrower’s full financial capacity. Rental income is considered if the applicant owns investment properties, though typically only 75% is included to account for vacancies and maintenance costs. Lenders verify this through tax returns and may request lease agreements or rent receipts.
Dividend and interest income can strengthen an application if it has been consistent over time. A two-year history, supported by tax filings and brokerage statements, is typically required. If the income fluctuates significantly, lenders may average the lower amounts or exclude it altogether. Similarly, retirement distributions or pensions must be expected to continue for at least three years, with supporting documentation.
Considering Consistency With Other Financial Records
Lenders compare tax returns with other financial documents to ensure reported income and liabilities align. Discrepancies between tax filings, bank statements, and W-2 or 1099 forms can raise concerns. If a borrower reports significantly higher earnings on a mortgage application than on tax returns, lenders may question the accuracy. Similarly, if bank deposits suggest a higher cash flow than reported taxable income, further clarification may be required.
Debt obligations must also be consistent across records. If tax returns show interest deductions for loans not disclosed on a mortgage application, lenders may suspect an attempt to conceal debt. Additionally, undisclosed business ownership or side income could prompt further scrutiny. To avoid delays, borrowers should ensure all financial records accurately reflect their income and liabilities before applying for a mortgage.