When you apply for a VA home loan, your income is reviewed in more ways than one. Not only does an underwriter review your most recent pay stubs and employment history, they also look at your most recent two years or more of tax returns.
That’s why it’s really important to know how your tax return can affect your home loan approval. For the majority of homebuyers, tax returns won’t cause issue, but for those select few, it’s really important to know how your income calculations may be adjusted based on certain scenarios.
What scenarios would those be?
Self-Employment Income/Owning a Business
Do you own your own business? Are you considered an independent contractor?
If you replied “yes” to either of these, it’ll be really important to sit down and take a look at your tax returns with your VA mortgage specialist. The only income that an underwriter will consider is the income claimed on your tax returns. The underwriter will be looking for several things on your return to calculate your income, mainly the following:
- What type of returns do you file? Do you just file an individual 1040 or do you file a separate business return? You will need to provide full copies of each return with all attachments.
- Were there any losses? What about deductions? An underwriter is going to use the business income after deductions (but adding back in depreciation). In some instances you may have been advised for tax purposes to file your return in a way that would provide you the best benefit, which may mean that you claimed a large amount of deductions and/or losses. Your underwriter will use the income listed on your return, so if you’re considering the purchase of a home, consult with your financial planner or tax specialist regarding your filing options.
- How many years? You will have to provide at least 2 years of returns for self-employment income to be considered, and frequently 3 years of returns will be requested if they’re available. Ideally your profit will increase year-over-year. In that case the underwriter will likely average the past few years income. If you have some ups and downs in income, or worse, a decline in income, the underwriter has the discretion to use the lower income number. You may also need to provide more than two years of returns if the underwriter believes your income to be volatile, so that he can get a better picture of earning history to assess the risk.
Commission and Bonus Income
If your income is made up in whole or in part of commission or bonuses, you need to ensure that your VA mortgage specialist is aware of how your pay breaks down on your tax returns. An underwriter will scrutinize your tax returns to determine how much of this income they will allow.
If you show an increase year over year in this income, then they’ll likely average out the past two years, assuming it can be documented that this income is likely to continue. If on the other hand, the commission or bonus goes down, it’s likely that an underwriter will use the lesser of the two years income. Worse yet, they could view that income as unreliable and not permit its use on your loan application at all.
In situations like this one, it’s really important for you to gather documentation or evidence that this income is likely to continue and determine what rate it will continue at. A good way of doing that is getting a letter from your employer.
Owning rental properties
If you own one or more rental properties, it’s possible you may be able to use the income from these properties on your loan application, or at least offset the mortgage payment amount on the property. When you have rental properties on your tax returns, an underwriter will calculate the income for the property based on the rent claimed minus losses.
If you show an overall loss instead of a profit, the amount of the loss will be added to your application as a debt and could result in a higher DTI ratio. There are some exceptions here, so make sure you discuss your specific situation with your VA mortgage specialist at the time of application.
If you’d like to get an overview of the VA loan process, check out this guide that will walk you though each step.
As always, email me if you have any questions.
Photo Courtesy John-Morgan