Banks ask a number of questions about a potential borrower’s assets, income and debt history. Lenders can no longer let applicants self-certify, simply taking them on their word that they can afford the monthly payments, after the mortgage crisis in 2008. Instead, banks must independently verify the creditworthiness of each borrower. Typically, pay stubs or Form W-2s provide sufficient evidence. On occasion, though, banks might require tax returns to verify a borrower’s income.
When Banks Might Require Returns
Verifying loan applicants’ income through tax returns requires more administrative work than other methods. Banks often simplify the income verification process by accepting certain types of evidence directly from the applicant. Wage-earning employees receive a Form W-2 from each employer every year, which shows the gross and net amounts of income, along with taxes withheld, that the employee had the previous year. Similarly, pay stubs show the amount of income for the pay period, along with month-to-date and year-to-date totals. Banks will often request documentation spanning anywhere between two pay periods to two years, depending on the size of the loans.
Self Employment and Other Income Sources
Applicants who are self-employed or receive substantial amounts of income not reported on a Form W-2, such as a croupier who receives infrequent, large cash tips from clients, might need to release tax returns to the bank as proof of income. Self-employed applicants receive different documentation from clients indicating the amount paid, but banks can’t rely on the information from the Form 1099 to be comprehensive or accurate. Instead, the only comprehensive picture of the applicant’s income comes from tax returns.
Requesting Tax Returns
Unlike Form W-2s or pay stubs, borrowers are responsible for preparing their own tax returns. Because of the potential for abuse, many lenders will only accept tax returns directly from the Internal Revenue Service. The IRS provides Form 4506-T for applicants to request copies of their tax return for the bank to review. If an applicant filed a joint return during any of the requested years, both people on the return will need to sign Form 4506-T to provide proper consent.
No Tax Return Filed
If an applicant didn’t file a tax return for any of the years the bank wants to see, filing Form 4506-T also provides the option to request verification of nonfiling. While this proves to the bank that an applicant didn’t file, it doesn’t provide any proof of income. The bank might deny the loan based on insufficient income history, or might impose additional requirements before approving the loan.
Sean Butner has been writing news articles, blog entries and feature pieces since 2005. His articles have appeared on the cover of "The Richland Sandstorm" and "The Palimpsest Files." He is completing graduate coursework in accounting through Texas A&M University-Commerce. He currently advises families on their insurance and financial planning needs.