Tuesday, February 10, 2015

This Employee Tax Deduction Could Kill Your Mortgage Eligibility

Scott Sheldon for Sonoma County Mortgages writes: You may want to rethink taking those extra deductions to minimize your tax liability this year if you plan to get a mortgage. Writing off expenses you incur as a W-2 employee can have lasting negative repercussions on your real income, an anchor  component of how home lenders determine your creditworthiness…
IRS Form 2106

You bring a mortgage company your w-2′s and pay stubs supporting high income. Your income should be no problem right? Well…not quite.

The numbers on your w-2s could be negated by how much expenses you elect to deduct against your income in the course of your employment. When you go to file your tax returns, your accountant may recommend maximizing your deductions to avoid incurring higher tax liability. No one wants to pay Uncle Sam right? In this line of thinking many taxpayers take an extra deduction in the form of 2106 expenses, many times, unknowingly hurting their mortgage chances.

The IRS understands that because your employer may not have an expense reimbursement policy or does not allow certain expenses to be refunded, you are permitted to write them off against your adjust gross income (AGI) as alternative.
Commons expenses may include, but are not limited to:

  • Tools,
  • Dues
  • Licensing
  • Subscriptions
  • Uniforms

Such costs may in fact be things that you’re expected to pay for with your occupation.
Banks don’t care about the reasoning, if it’s there, then its counted, clear as day.
Writing these off against your income reduces your taxable income, making you less creditworthy as you can’t qualify for as much mortgage amount with lower income. Your income on your  W-2 & pay stubs is not the whole picture. Your real income is lower because the 2106 expenses comes directly off total income otherwise used to offset other expenses such as a car payment, credit card payment, a student loan payment and housing payment comprised of taxes, insurance, principal, and interest along with any other housing related carrying costs like a homeowners association or special assessment within the property taxes.

Mechanics Of Lending On Unreimbursed Employee Expenses
Lenders know your real income is your gross wages pretax, less 2106 expenses. Here’s an example-Let’s say you have earned $100,000 per year of income, a nice salary of $8,333 per month pretax which is what lenders use to qualify you  to take on a mortgage payment.
In addition, lets say your employer mandates their employes pay for their own tools, dues and licensing- for the last two years you have taken a $15,000 write off in the form of unreimbursed employee business expenses, $30,000 per year collectively for the most recent last 24 months. Broken down monthly, that’s $1,250 coming off your gross income.
In this example the lender would use $7,083 in income instead, thus hurting making you look less strong on paper.

Expect lenders to average 2106 expenses from your federal income tax returns for the most recent last two years. If in the previous year you didn’t take 2106 expenses and then on the most recent taxable year, you do take 2106 expenses, these numbers will be averaged by 12 months rather than 24.

The Continuance Factor
Lender’s want to make loans, but by the same token, they also want to cover their butt to avoid buy back risk (when a lender is forced to repurchase loan usually due to an underwriting oversight).

If you can demonstrate and explain why future expense deduction will no longer occur, you improve your loan chances. The key is–your explanation must hold water and be supported on paper.

If for example your employer changed their expense reimbursement policy or you now have a different title where you no longer need to take these expenses anymore, these types of scenarios would qualify to have the 2106 expenses you previously took in years past omitted in the lending credit analysis.

Be prepared to show full and complete detailed supporting documentation in this type of scenario. Moving forward with a mortgage loan, there has to be a blatant reason or some sort of change in order for the lender to not count these expenses against your income, perhaps you no longer are working full-time due to an injury and are on permanent disability income.  These scenarios make sense to a banker.

If due to your unique circumstances you have to take these expenses as per the advice of your qualified tax professional, here’s some considerations to be aware of.

If: you carry consumer debt such as car loans, credit card debt, and student loans and are considering taking 2106 business expenses.

Then: how much of these 2106 expenses you claim on your tax returns becomes even more important- as a general rule of thumb, keep the 2106 annualized figures to no more than 5% of your gross income.

If:you don’t carry consumer obligations or any other debt other than housing.
Then: you may have some more allowances with the amount of expenses you can write off against your income–talk to tax professional and a lender.

Mortgage Tip: The situation to avoid at all costs is taking on a mortgage payment that combined with your other non-housing related obligations is at 45% of your income not taking into consideration 2106 expenses and hoping the math is just going to automatically work in your favor.

Put simply, you may have to make some concessions if you want a mortgage approval like:

  • Reducing your loan amount and/or purchase price of the property
  • Reduce your fire insurance premium (seems trivial-but, this has saved multiple transactions speaking from experience)
  • Reducing the interest rate associated with your loan by virtue of paying upfront fees in the form of points to generate a lower payment
  • Pay off car loan, or credit card balance or any other obligation affecting  your income
  • Put more money down
  • Change loan programs
  • Get a cosigner

Ultimately, if the amount of mortgage you are trying to qualify for becomes too much with your debt load, you will need to make some change. Ask your lender for advice on improving your debts to qualify or get a second opinion from another mortgage broker.

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