One of the pillars of sound residential mortgage lending for any bank is verifying the borrower’s ability to repay the loan. As part of the lender’s process to confirm you do indeed have the income to pay back the borrowed money, the lender will ask you for your income documents. Income documents come in many forms, however the most common ones are paystubs, W-2’s, and tax returns. As a mortgage loan officer I’m commonly asked by borrowers why I have to ask for tax returns. What gives? Don’t the paystubs and W-2’s tell the lender all they need to know?

On the most basic and simple kind of mortgage loans, the lender may not require they see your tax returns, however, rarely are more loans this simple. Today Fannie Mae and Freddie Mac, the two government sponsored entities supporting the US mortgage industry by guaranteeing most mortgage loans and being the largest buyers of mortgage loans, do not mandate that the tax returns are obtained and reviewed by your lender if your financial situation is very simple and your mortgage is very simple. Immediately after the Great Recession Fannie Mae and Freddie Mac required tax returns in more and more situations, however as the economy improved they required tax returns in less and less situations. Today, other than borrowers with the most basic financial situations with the most basic kind of mortgage, tax returns will be required. That being said, even if your financial situation is very simple, the bank may ask for them anyways.

The reasons why lenders will require you provide your tax returns in most cases is that your paystubs and W-2’s only tell part of the story. A lot of additional information can be gleaned from reviewing an individuals tax returns, therefore, in most cases your bank will ask to see them. Not only will your financial situation be clearer to the bank, and therefore they can make a more informed decision on whether or not to lend you their money, it also limits their exposure to fraud. For example, it reduces the chances that unscrupulous borrowers try to hide information such as alimony or child support a borrower is paying and not telling the bank about, losses on a business that the borrower isn’t telling the bank about, or something similar. Borrowers might choose to not tell the bank because these unscrupulous borrowers might know that the bank would deny their loan if they knew about these losses in income.

Even on basic and simple loans, Fannie Mae require that lenders obtain copies of the borrower’s signed federal income tax returns filed with the IRS for the past two years for the following sources of income or employment if the borrower:

•earns 25% or more of his or her income from commissions;

•is employed by family members;

•is employed by interested parties to the property sale or purchase;

•receives rental income from an investment property;

•receives income from temporary or periodic employment (or unemployment) or employment that is subject to time limits, such as a contract employee or a tradesman;

•receives income from capital gains, royalties, real estate, or other miscellaneous non-employment earnings reported on IRS Form 1099;

•receives income that cannot otherwise be verified by an independent and knowledgeable source;

•uses foreign income to qualify;

•uses interest and dividend income to qualify;

•uses tip income reported on IRS Form 4137 that was not reported by the employer on the W-2 to qualify; or

•receives income from sole proprietorships, limited liability companies, partnerships, or corporations, or any other type of business structure in which the borrower has a 25% or greater ownership interest. Borrowers with a 25% or greater ownership interest are considered self-employed.