Tax Advantages vs. Mortgage Benefits: Understanding the Distinction

When was the last time you did your best to pay more in taxes?

The reality is that most of us do our best to reduce tax liability. We claim exemptions and deduct as many eligible expenses as possible. Unfortunately, if you aren’t careful, you might find that the deductions you claim on your tax return can hurt the chances that you will get qualified for the mortgage you want.

Lenders Care About Your Income

Lenders care about your income. They look at your pay stubs, tax returns, and bank accounts to see how money moves through your personal economy. A lender wants to know that you will be able to consistently handle payments. If it looks like you have a lower income on paper, the lender is going to reduce the amount you are approved for, based on how the lender views your ability to make a monthly payment.

Example: 2106 Expenses Related to Your Job

When you have a steady job, it’s common to assume that you will be able to qualify easily for a mortgage based on your income. However, if you have been deducting job-related unreimbursed expenses on Form 2016 of your tax return, that changes the equation. These unreimbursed expenses are needed for your job, but your employer doesn’t offer to pay you back for how you use the money. You get a nice tax deduction for these costs, saving you money on April 15.

Unfortunately, this tax deduction can also reduce your qualifiable income. If a lender takes a look at your 2106 expenses, it is pretty easy to assume that your monthly ability to pay the mortgage will be impacted. Perhaps you make $5,000 per month ($60,000 a year). However, you are required to keep your licenses up to date, pay dues to a professional organization, and purchase tools. Maybe you even have to pay for two uniforms and keep them clean. If you spend $3,000 a year on these unreimbursed expenses, that averages out to $250 per month.

When a lender looks at your income to determine the size of your mortgage — based on the monthly payment — that $250 will matter. Now, your income will be considered at $4,750. Take that lower income, and add in other obligations like car loans, student loans, credit cards, and other expenses, and suddenly your ability to make a higher loan payment disappears (at least in the eyes of the lender).

Depending on various factors, having $250 less per month could mean the difference between getting a $200,000 mortgage and a $145,000 mortgage. That tax deduction means that you have to spend $55,000 less on a home than you had expected.

In order to avoid having these types of expenses included in your income, you need to be able to convince a lender that you won’t be paying them going forward. Perhaps your employer will start reimbursing you. Maybe you can show that you don’t need to spend the full $3,000 each year to meet your employer’s requirements. If you can show that these expenses will dwindle over time, you might be able to convince an underwriting department to take a chance on you.

In many cases, your tax deductions won’t have a huge impact on the size of your mortgage. Many of your deductions are one-time expenses, or optional expenses that you can cut if needed, and lenders understand that. Expenses that are required as part of your work, on the other hand, are much more permanent and of greater concern to lenders.

As you prepare your taxes, keep this mind, and weigh your tax deduction against the possibility that you will be approved for a smaller mortgage.