Whether you’re self-employed or you have an employer, FHA loan guidelines require the lender to review recent federal income tax returns. Even if you get paid the very same amount on the 15th and 30th of each and every month, you can expect to be asked for copies of your two most recent transcripts. But lenders do more than just review the income listed on the returns, they also use those returns and transcripts for other things as well.
If you have an employer and have regular pay check stubs and W2 forms from the previous two years, you’ll also be asked to sign a form called the 4506-T. The “T” stands for transcript, and this signed form gives your FHA lender authorization to contact the IRS directly for copies of your most recent transcripts.
Upon receipt of your transcripts, your lender will compare the income reported to the IRS with the income on the actual loan application. If there is a discrepancy, the lender will want an explanation why the amounts are different.
Most often the difference is due to income reported that was not from an employer and not regularly received. For example, a couple states they make $9,000 per month yet the transcripts show a little more than that. One year of income at $9,000 per month is $108,000. If the transcripts show say $115,000, the lender will ask for an explanation. Or, more importantly, if the transcripts show $98,000, the lender will be more concerned.
Why does the IRS show $10,000 less than what the application says? A common reason is one person was not working for a brief period due to an illness or leave of absence. The 4506-T is simply a third party verification of income. On this form, the lender will first identify the years being requested. If those years aren’t listed, write them in on your own.
If you’re self-employed, your tax returns require a bit more scrutiny. Who is self-employed in a lender’s eyes? Anyone that owns at least 25% of any business is considered self-employed and will be underwritten as such. Lenders will ask for your two most recent federal income tax returns. Because qualifying for a mortgage depends greatly upon how much you make each month, your lender will average your income for the past two years. If your income last year was $110,000 and the year before $105,000, the lender will add those amounts together then divide by 24 to get a monthly average of $8,958.
In a lender’s eyes, this income is not only consistent but increased from one year to the next. The lender will also make a determination the income is likely to continue into the future. Note, the income used is the net income after expenses, not gross business income.
Now let’s say the income two years ago was $110,000 and last year $105,000. The average income is still the same but in this instance, the income falls. Such a small drop won’t be an issue with an FHA lender but could be if the income drops by an even greater amount. If two years ago the income was $110,000 and last year $85,000, that could indicate a business with some problems and the determination the income will likely continue into the future could be in question.
Is the business failing? Did something happen that caused a temporary drop in income? When income makes a dramatic drop, borrowers can be expected to provide an explanation, documentation of the event and showing the lender that whatever caused the income to fall is temporary in nature or more permanent. Learn more under the FHA home mortgage details.
Keep in mind, the requirements above are pretty much standard for all Conventional, Jumbo and government loan programs today. Buyers that have questions can reach us by calling the number above, or just submit the Info Request form on this page.