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How Your Taxes Could Hurt Your Homebuying Chances

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Are you planning on buying or refinancing a home this year? When it comes to your taxes, be careful. If you’re trying to save a few bucks when paying Uncle Sam, you might be doing things that could cost you your mortgage.

When You’re an Employee

First, let’s take a look at the tax moves you make that could threaten your mortgage if you’re a W-2 employee.

Taking expenses you incur in the course of your employment as a write-off against your income can actually be bad news. IRS Form 2106 for employee business expenses can destroy a mortgage application because it directly reduces your income. If you have expenses such as mileage, dues, office supplies, tools — any costs you incur as an employee — these items are best paid for by your employer. You pay a buck, you’re reimbursed a buck, dollar for dollar, on each expense.

Lenders, in addition to wanting your W-2s and pay stubs, are always going to ask for two years of federal income tax returns. On these tax returns, if you take additional non-reimbursed business expenses, the lender will have to account for these liabilities.

If you can document specifically what the 2106 liabilities on the tax return were with clear and concise documentation, along with an employee letter explaining the nature of their reimbursement policy, and you can show these expenses were a one-time occurrence, you can petition for the lender to omit the 2106 business expenses. This would allow you to increase your buying power.

When You’re Self-Employed

Writing off as much of your expenses as possible can do wonders for your tax return. By subtracting your expenses from your gross income, you show a lower net income, thereby reducing your tax liability. But this comes at a cost — yep, your loan application. The relationship between your total income and liabilities is extremely important for lenders when determining whether or not to make your mortgage loan. So showing less income to offset a housing payment can spell bad news for any self-employed consumer seeking home loan financing.

It then gets even trickier for self-employed individuals, because mortgage lenders use a 24-month averaged income. In other words, if you showed a high income one year and low income another year, the lower income tax returns would bring down your average income. To offset the numbers, you would have to show double-profits in a taxable calendar year.

Mortgage Tip: When it comes to writing off your expenses, you want to show bigger expenses in depletion, depreciation and business use of the home, as well as in the meals and entertainment section. The bigger these numbers are, the more income is shown because the lender can add back these expenses and give a self-employed individual more income necessary for loan qualifying.

By maximizing your net profit, this will show the maximum income on paper necessary for handling a total mortgage payment. With business-specific tax returns, the same thing applies.  

When You Own Rental Property

Here’s a big mistake: Not claiming rental property on a Schedule E when the property truly is rental property. If you don’t claim the rental property as such, nor take depreciation and omit income this also creates red flag to lenders. Why? For starters, it raises occupancy questions, which is a risk characteristic for every mortgage application.

If you have rental property, but somebody else makes the mortgage payment, and you give them the mortgage interest adoption that you otherwise are entitled to, the lender will want a detailed explanation. However, the liability still remains as yours.

There’s one more thing to consider: If you’re trying to secure a mortgage in the next 60 days, but the IRS is still processing your most recent tax returns, understand that your transaction may very well be delayed until the lender has those returns in hand. The lender will want to verify your income by looking at the validated tax returns from the previous two years, along with your pay stubs and W-2s.

As always, be sure to speak with your tax adviser regarding your individual specific tax and income situation.

More on Mortgages and Home Buying:

Image: Karen Roach

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  • http://www.influenceinvesting.com John Sheldon

    Thanks very much for your insight, Scott, and, no, I don’t think we’re related.

    The key here is to always remember that it’s a double-edged sword. Either you are able to lower your taxes by claiming more expenses or you have to NOT claim the expenses to have a higher net income and ultimately pay more taxes. Of course, the latter will help you qualify for a loan better. So, like I said, it cuts both ways.

    Thanks again for bringing this to our attention though, Scott, as I think many people may misunderstand this in the years before they are preparing to buy their home. Thanks very much!

  • http://www.credit.com/ Credit.com Credit Experts

    Scott Sheldon replies: Hi John yes I don’t think we’re related, but nice last name. Agreed pay more in taxes, show more income and qualify more easily for a mortgage. Pay less in taxes, show less income, getting a mortgage will be difficult.

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