Taxable Income and Home Loan Approval

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6 days and counting until you and Uncle Sam face off (if you have not already).   The HOUSE Team wanted to send you a friendly reminder that if you are looking to buy a home soon or refinance your current mortgage at today’s record low rates keep this in mind – your taxable income may factor into your mortgage approval.  Consider the following 2 Q & A’s for a moment.

Q: How do tax payers save on their income taxes?

A:  One option is to write down their taxable income by claiming expenses that effectively reduce their net taxable income.  Income tax on $50k in taxable income is a lot less than income tax on $80k taxable income.

Q: How do mortgage lenders qualify borrowers for a new home loan (purchase or refinance)?

A: One of the primary factors is the borrower’s income that is available to pay normal living expenses.  A borrower can qualify for a larger loan amount if they earn $80k in income versus the loan they could qualify for if they earn $50k in income.

When combining the 2 ideas above borrowers often find themselves at crossroads between saving on income taxes and having enough income to qualify for a mortgage loan.  Here is why:

IRS Perspective on income:

Gross Income (dollars taxpayer brings in): $80k

Tax Deductions (expenses that tax payer paid before they got to “use” their income for normal expenses): $30k

Net taxable income (gross income minus tax deductions): $50k

Mortgage Underwriter’s Perspective on income:

Gross income (dollars borrower brings in): $80k

Tax Deductions (money that a borrower could not use toward normal expenses): $30k

Net Income (Income left to pay normal expenses): $50k

This is a super simplified example that outlines the concept many loan applicants find themselves stuck within after it’s too late.   Why?  If a borrower says they spent $30k on advertising expenses out of their income (to keep it simple) why would an underwriter give that borrower credit for that $30k in income?  The borrower in this case did not have the opportunity to use that money toward their own bills.  They only had the $50k that was left over – that is the income they had access to for living expenses.  There are certain tax deductible items that can be added back into a borrower’s income such as depreciation, business mileage and large onetime expenses.

This is not a message stating to tailor fit your tax returns and income around your mortgage qualification needs.  Taxes need to accurately reflect your income/expense profile for the given tax year.  We just want you to know how the IRS and Mortgage worlds intersect!  Please let us know how we can help you or someone you know purchase, refinance or renovate this spring!

By Jeremy House


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