You probably already know qualifying for a mortgage requires an acceptable credit score, sufficient assets and stable income. All of these show you can support a mortgage payment, plus other liabilities. But what if you have “paper losses” on your tax returns? The mortgage process can get a little trickier. Here’s what you need to know.
You Have Rental Income Losses
On almost every mortgage loan application this can come back to bite the borrower. This is because rental losses usually represent more expenses going out than there is revenue to cover the property. Lenders use a special Fannie Mae formula, which in most instances makes losses look even worse. This is because the expenses are added back into the mortgage payment, then deducted from it over a 24-month period.
It is important to note that, when purchasing a rental for the first time, some lenders use an exception basis. The exception they are going to use is 75% of the projected market rentals. This is to help offset the mortgage payment as long as you are specifically purchasing a rental property.
You Have a Schedule C
This is a biggie. No one wants to pay an excess amount of taxes, especially self-employed individuals. You may be aware taxation is higher for self-employed individuals. So it goes without saying: Every accountant wants to be a hero by saving you money when helping with your tax returns. They could, however, be doing this at the expense of you refinancing or buying a home.
Writing off all your expenses, or worse, showing negative income means the lender has less income to offset a proposed mortgage payment. Even if you own a home already, have excellent credit and have an impeccable payment history, it does not matter. The income on paper is what lenders look at.
You Have Entity Losses
The following scenario is a common one where borrowers pay themselves a W-2 wage along with a pay stub, at the expense of bleeding the company dry. This will become problematic, because there almost certainly will be lower income figures. The same income figures the borrower is trying to qualify with.
Any negative income being reported on personal or corporate tax returns, will hurt your chances of qualifying for financing. As a result, one of these may be an offset, but they are not limited to the following:
- Waiting until the following year – Depending on the severity of how much income loss there is, you may need to do a two-in-one. This means showing two years of income in one year. This is to offset the two year averaging lenders use when calculating your income.
- Changing loan programs – This could be an array of different things, but it may mean going from a conventional mortgage to a FHA mortgage for example.
- Investigating more – You might need to put more money down to purchase a home than you otherwise thought. You would do this if your income is lower than what your purchase price expectations are.
- Paying off debt – Depending on your financial scenario, paying off consumer obligations is always a smart and healthy approach, and can improve your overall credit scores, even if it requires some of your cash. (You can check two of your credit scores free on Credit.com.)
What should you do if you know you want to qualify for financing and you currently have tax returns that contain losses? First and foremost, consult with your tax professional. Learn what your options are. Once armed with those options, talk to a lender skilled enough to help you understand how much financial power you may have in the marketplace.