Taxes and Debt to income

Good news from a CPA turns bad news from your Mortgage Broker

Taxes and Debt to Income. Urgh…Tax season! That was half a year ago. Really! Why would I think about this now? So many things happen along the way in a fiscal year. But if we plan now and line up our future finances we can be better prepared for a home purchase and even improve our financial picture for our ultimate goal, retirement!

Come April 15th we all want that good news from our CPA that he or she found many items for us to write off or another to place to put these items on our tax return to get a larger refund from the Internal Revenue Service.  There is no doubt that this is a great feeling! But how will this impact our future purchasing power once we have submitted our returns? 

Many things must be considered when we complete a tax return and talking about your goals for the near future as well as planning for the long term future or even retirement planning, all this and more should be considered with your CPA.

 So what the heck is a Mortgage Broker talking to me about this for?

How you file your tax returns will be a big part of how much money you can borrow, especially if you’re self-employed. I am sure the IRS would be thrilled if everyone just completed the 1040EZ form for filing. After all, for the IRS employees this would make their jobs easier and they could generate more income for the government allowing them to have bigger and longer employee conferences (parties) on the tax payers’ dime.

However the higher the tax returns the more you should be able to borrow right? But wait a minute, the more money we claim to have made, the more taxes we have to pay.  That’s crazy, why would I want to pay more taxes? Don’t we all go through great lengths to avoid paying more in taxes?

Talking to your accountant throughout the year can help you better plan, not only for tax planning but for achieving your goals and dreams. If you have a goal to purchase that new home or even that second home now that you’re nearing retirement or if you’re that spouse who decided to start that part time in-home business now that the kids are in school and you want to write off every possible expense you can dream of. But wait a minute, let’s skip pass the possibilities of triggering an IRA audit and get to your income. So often I see people write off too many expenses, “Really” yes! Let me explain, you told your CPA you have a new in home business so he tells you to write off the extra room, you throw in the house phone, cable and electric bills etc. you get my point. But now you get to show that as a loss of $15,483 on your returns this is awesome the CPA saved you a little over $3,000 in taxes right? This guy is awesome!

Here is the kicker let’s say your spouse has been a school teacher or fireman for the last 20 years earning a steady $55,000 a year and now that great thought of helping out the family you have a business lost reducing that income down to under $40,000 and with two car payments and all those credit cards you used for the new business your debt to income ratio is through the roof. You have declining income of over 10% so even with a great credit score 740 score no lender can refinance your mortgage from that 6.5% rate down to 4.25 cause you do not qualify. And if you’re that person looking to retire on a pension or social security and even if you didn’t have all that other debt your declining income hurts your ability to purchase that second home or complete the refinancing of your home.

The reality is with the enforcement of Dodd/Frank and the eliminating of stated income for mortgage loans, whether for a new purchase or refinancing your current home, income is the number one factor in meeting the requirements for the “Ability to Repay Rule”.

Remember taking deductions on your tax returns is an option; it’s not something you have to do. Be honest to yourself and plan on what you need with your CPA. Be smart about your tax returns and income. Ask your CPA how best to use your income and deductions.  Think about the differences if you pay a little more in taxes and leaving your net income up higher and how you can benefit better by having more purchasing power. Remember once you file your tax returns and then use them for a mortgage loan you cannot go back later and amend your taxes by reducing your income to get money back. This is loan fraud and the lender may be able to foreclose on your home even if you’re now in prison.

In meeting the requirements for the “Ability to Repay Rule”, Lenders must verify your income through a third party. So as for your tax returns they must be verified through the IRS. The Lender must verify that the tax returns you have submitted for your mortgage loan matches the returns you filed with the IRS. This takes time and is not a simple process, if you have filed just a few days before you applied for your mortgage loan we could be delayed. In general it can take the IRS 4 to 6 weeks for your returns to be processed for the lenders to pull a copy of your tax transcripts. Just because you have filed electronically does not mean the IRS has completed the process in the system that allows the lender to obtain verification of your returns.

Believe it or not we still have people who think they can play the old shell game of submitting one set of tax returns to the IRS and a different set to your lender it’s not going to work. You can’t have it both ways.

There are clear advantages for being honest with your tax returns. The possibility of greater purchasing power, possible higher social security income at retirement time, less chance for IRS audits, and if you do get audited like I have, you win the audits. I have two wins the IRS zero.

In summary know your goals and dreams, plan ahead with a seasoned professional and ask questions.

Leave a Reply