Vail Daily column: Plan for taxes and mortgages
As tax time is approaching, it’s time for my annual discussion of planning not only for your taxes but for your borrowing plans this year as well. Seldom a month goes by where I don’t have to deliver the bad news to a self-employed borrower that they are sometimes less than $20 per month short on taxable income to qualify for a conventional mortgage loan and we will have to hope things go a little better this year. And while I say “conventional” mortgage loan, that doesn’t mean they could qualify for an unconventional mortgage loan either as those are harder to get than a conventional loan, at least when it comes to income calculations.
In the past, self-employed borrowers had the best of both worlds. They could write off every conceivable thing the IRS would let them get away with and save thousands on taxes showing a lower income.
In addition, when it was time to apply for a loan they could, as we used to say, put down the gross instead of the net. This meant that borrowers could qualify for much larger loan amounts than they might using just the adjusted net taxable income after taxes. This was possible by using a stated income loan program.
The original stated income loans worked quite well for over 20 years without an abnormally high default rate. This is because initially these programs were wisely restricted to borrowers who most likely have adequate cash flow to pay their bills but couldn’t qualify using their tax returns due to writing off their car, home office and other expenses.
Also, in many cases borrowers with adequate income showing on their taxes often could not use certain types of income toward qualifying and benefited from stated income as well. This included rental income from a roommate or even tax-free bond interest in some instances.
Now stated income loan programs are long gone and not coming back anytime soon, and many borrowers who have been making every payment for years, have great credit and equity find themselves trapped in their loans and their homes because they cannot refi or qualify for a new purchase money mortgage.
Borrowers must meet a stringent debt to income calculation reflecting only the income on their tax returns divided by their housing expense and minimum payments on other debts. If they are even one dollar short, they don’t qualify regardless of what other compensating factors they might have to their credit (such as a pile of liquid assets or a very low loan to value).
As such, I find myself with a new dimension to my work, and that is working with borrowers before they file their taxes to counsel them on just how to balance paying more taxes vs. being stuck in their current loans.
We often have to tell borrowers (and their sometimes miffed accountants) that they would be wise not to take every last legitimate deduction in order to qualify for a new mortgage loan this year.
NOT REALLY SAVING
Here’s an example. Recently we ran the numbers for a client who could lower his loan payments by about $1,000 per month. However, he was shy on income by about $30,000 due to his ability to write off many expenses. That $30,000 in write-offs was saving him about $9,000 in taxes, and my guy thought he was pretty smart to keep his taxes low.
However, what he was saving in taxes he was paying in additional interest by not being able to qualify for a new loan, so he really was not saving a thing but was losing money overall by not being able to refinance.
Until recently, we had to average two years of self-employment income, but now Fannie and Freddie loans generally (though not always) call for one year, which can simplify the process significantly. It gives borrowers the option of biting the bullet and paying more taxes for one year instead of two.
There are very clear laws that say borrowers cannot claim more gross income than they generate, but no law says you have to claim every deduction you are entitled to, and lenders calculate a self-employed borrower’s qualification on his net taxable income.
While I have no doubt spat on the holy grail of tax preparers here, I challenge them to advise their clients that they are better off paying more interest and less taxes when the difference is as dramatic as it was for my client. The tax savings is for one year, and the interest savings are for the life of the loan. The year after the loan, the client can go back to writing off his mileage to the grocery store as looking at real estate between his house and the store.
The key is to plan your tax strategy with your borrowing strategy. This requires collaboration before you file your return between you, your lender and your tax adviser.
In addition, keep in mind that your tax returns have to be verified with the IRS as matching what was actually filed. I would hope nobody would ever think of giving their lender false tax returns, but the issue is it can take up to six weeks once you file your returns for them to be verifiable by the lender. Thus if you are planning to refi or get a purchase money mortgage soon and need the 2014 income to qualify, then you had best get those returns filed.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group and may be reached at 970-748-0342. He welcomes mortgage related inquiries from readers. A collection of the best of The Mountain Mortgage Guy columns can be found on his website and blog at http://www.mtnmortgageguy.com.