If there’s one thing that all lenders look at when you apply for a mortgage, it’s your income. You have to be able to prove beyond a reasonable doubt that you can afford the loan. In fact, ever since the housing crisis, all lenders are required to verify income with paystubs, W-2s, and tax returns, if applicable.
What happens if your taxes don’t reflect your true income though? This happens for self-employed borrowers and even borrowers working on commission. They write off their expenses to lower their tax liability, but end up without the mortgage they need because their taxes show a loss.
Luckily, there is a way to get a mortgage even without your tax documents.
You may be cringing at the thought of a subprime loan – you aren’t alone. Many people have negative images of the subprime program. Today, it’s a much safer loan program. While lenders that offer these alternative loans don’t need to follow the strict Qualified Mortgage guidelines that require lenders to check your tax documents, they still have to follow the Ability to Repay Rules. This means the lender is certain beyond a reasonable doubt that you can afford the loan. The only way they can be certain of this is to verify your income.
How Subprime Lenders Verify Income Without Tax Returns
So how do the subprime lenders get away with it? They use your bank statements rather than your tax returns. In order for this to work, though, you must receive regular income deposited into your bank account. The income you do receive should be in line with what is standard for the industry as well.
Lenders usually ask for the last 12 to 24 months of bank statements to see the flow of income coming into your bank account. This allows them to take an average of your income rather than relying on one or two months’ worth of income. The average allows lenders to account for the highs and lows that occur in any business. In other words, they won’t qualify you for ‘too much mortgage,’ as that would put you and the lender in trouble should your income decline.
Other Qualifying Factors
So what are the other qualifying factors that you need if you don’t use tax returns to verify your income? Typically, you’ll need good credit, a low debt ratio, and assets on hand. These compensating factors make up for the risk the lender takes by not looking at your tax returns and using your bank statements instead.
Just what credit score do you need? It really depends on the lender. Some lenders require high credit scores of around 700. Others may cut you some slack as long as you have a decent credit history. In other words, you don’t have a lot of late payments and you don’t have collections or bankruptcies reporting.
As far as the debt ratio and reserves, again, it is up to lender discretion. Some lenders will require conforming debt ratios of 28% on the front-end and 36% on the back-end. Other lenders will be a bit more lenient, allowing you to have higher debt ratios as long as your income is consistent.
As far as reserves, the more you have on hand, the better off your chances of approval. Reserves are money you have set aside to cover your mortgage payment should your income fall. Lenders count your reserves based on the amount of money you have compared to the mortgage payment. For example, if your mortgage payment is $1,500 and you have $8,000 on hand, you have five months of reserves available. The more reserves you have, the better your chances of approval.
The key to getting a mortgage without tax returns is to find a willing lender. You won’t be able to use any of the standard loan programs, such as conventional, FHA, VA, or USDA. Instead, you’ll need to find a lender that keeps loans on their books and will grant you an exception if you are self-employed or work on commission.