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Why Tax Returns Matter in Mortgage

Why Tax Returns Matter in Mortgage

Have you ever applied for a mortgage and wondered why your lender asked for your tax returns for the previous two years?

Debt-To-Income Ratio

One of the main qualifying factors used to approve a mortgage is your debt-to-income ratio (DTI). This number is calculated by dividing all of your debt by your income.

Your DTI helps the lender determine if you can afford the new loan, per their guidelines. And it gives the lender an idea of how much money you have left over after your minimum bills have been paid.

Lenders first determine your monthly debt by pulling your credit report and adding the payments on all open debt. Then, they determine your income. If you are a salaried or hourly employee, your income is calculated using the last 30 days of pay stubs and your last two W-2 statements.

So Why Tax Returns?

Lenders also ask for your tax returns (1040) because unlike paystubs and W-2s, tax returns help to explain the entire story about your income.

The lender needs to know if you are writing anything off. Tax write-offs may pose a problem with your mortgage application. The general rule is that if you are not paying taxes on it, the lender is not going to allow you to use it as income.

Losses, Unreimbursed Expenses, and Depreciation

The most common tax write-offs are unreimbursed business expenses, Schedule C losses, and Schedule E losses.

Unreimbursed business expenses are shown on Line 21 of the Schedule A, and can include mileage, uniforms, dry cleaning, cell phone bills, industry publications/journals, job trainings, etc.

If you have a self-employment business you might file a Schedule C or a Schedule E depending on how you structure the business. A Schedule E may also be filed if you own rental property or receive royalties. Both Schedule C and Schedule E may show losses.

Anything listed on line 21 of the Schedule A and any losses from Schedules C or E may be netted out of your income.

On your Schedule C, however, any depreciation that you claim may be added back into your income. The same applies if you file S-Corp returns for your Schedule E self-employment business. Any depreciation filed on those returns may also be added back in to your income.

More to the Story

The story of your tax returns does not end there, however. Your tax returns will also tell the lender if your home has any farm income, if you pay alimony, or if you have received unemployment income.

If you file a Schedule F (farm income) on the property you are refinancing, it may make you ineligible for certain mortgage programs.

If your tax returns list alimony paid to an ex-spouse, that alimony payment may need to be listed as a liability when calculating your debt to income ratio. This can affect your approval.

Your returns will also show if you have received any unemployment compensation, which might require a letter of explanation about your employment history. This can also affect your approval.

Your tax returns play an integral role in the qualification process of your mortgage. If you have any questions or concerns about whether or not you will qualify, a Meridian Home Mortgage Loan Officer is available to answer your questions. Please do not hesitate to contact us.

Offset Your Underwater Mortgage – Rent Out Your House

Offset Your Underwater Mortgage – Rent Out Your House

While you’re waiting for HARP 3.0 to make its way through Congress, how do ease the financial pain of owing more on your home than it’s worth? One option is to rent out an available spare room, your basement or attic, an in-law suite – or your entire house!

Thanks to the Internet – and lots of savvy entrepreneurs – you can now list your room or home (or even your tree house, igloo or tropical island) on sites such as AirBNB.com and GameDay Housing.com.

Used by travelers, students, visiting faculty, sports fans, convention attendees – and people who simply don’t want to stay in a hotel – these sites let you easily market the space you have for rent – while taking care of all the backend issues for you, such as collecting money and screening people.

Make your empty space work for you

By renting out your available space, you help defray homeownership costs. And, depending on where you live and the space you have available, you can potentially collect more money in rent in just a few short months than you actually pay in mortgage all year.

Let’s say you live in an area that’s in a summer or winter vacation destination. You could rent a room or your entire home for the “season” (summer or winter) by the day, week or month. Vacation rentals during summer “high season” on Cape Cod, for example, can run anywhere from $800 to $4,000 per week.

(Of course, if you rent out your home for a season, you’ll have to find somewhere to go – i.e. in-laws, friends, etc.).

You don’t have to live in a tourist destination to gain the benefits of renting out space in your home. If you live in a college town, for example, you could rent to visiting faculty or students. If you live in a city that has a convention center, you can rent your spare room to exhibition or convention attendees – especially since local hotels often sell out in advance.

Is renting out your home for you?

When deciding whether to rent out unused space in your home – be it the basement or a spare room – you’ll want to consider the following:

Your family’s need for privacy – Do you want renters to become part of your family or no? You may want to draft “house rules” that explain to which parts of the house people have access and when.

Security – When determining which site to list your available space, do carefully consider how you’ll screen people. Some of the listing sites, such as AirBNB, have built-in security. Renters and rentees must verify their ID and sign in using a social network such as Facebook. AirBNB also insures each rental – no matter the size – for one million dollars.

Amenities – Does your space come with its own bathroom? Does it have a separate entrance? Will people have access to your kitchen? Do you have wifi? These amenities can help increase your rental rate – and make your space more attractive to renters.

Check applicable laws and regulations

Before renting out any part of your house, check with your town or city hall and state for any landlord-tenant laws or zoning ordinances. You’ll also want to call your insurance agent regarding your homeowner’s policy. And, don’t forget to call your accountant. If you meet certain conditions, the rental income you generate could be tax-free.

Rental listing sites

You can find dozens of places where you can list your unused space for rent – everything from Craigslist.com to Roommate.com. We’ve listed three of our favorites as they offer you a wealth of services – and they place a high emphasis on security:

AirB2B – Started by three guys with airbeds in 2008, AirB2B now boosts over 300,000 listings worldwide in over 33,000 cities. The site lets you upload photos of your space and includes a calendar where renters can see which days your rental is available. (And, if your bucket list includes a stay in a lighthouse, this is the place to book that wish.)

Gameday Housing – Owned and managed by real estate professionals who oversee the entire process for you, Gameday Housing allows you to list your home for rent to people attending sports events. According to the site, people who do this can earn $15,000 annually.

Homeaway.com – If you have a vacation home or second home, you can rent it out via this site. Homeaway offers five subscription levels that include advertising and listing options.