Why business tax returns are important to lenders
Whenever you apply for a mortgage loan, chances are that the lender you are borrowing from will request for copies of tax returns and bank statements. These are among the most important documents lenders ask for during the loan application process.
Why do different lenders need your tax returns and bank statements? It has all to do with your income as well as asset verification. Lenders mainly seek for these documents for two reasons.
The first one is to know how much money you earn and the second reason is to find out how much you have in the bank. Let’s look at each case deeply.
Why lenders ask for bank statements
When applying for a loan, the lender will always want to know everything regarding your current financial situation. For instance, they will want to find out how much you have in the bank and for how long that money has been there. This process is also referred to as verification.
Lenders are always keen to have this information in order to assess your general financial ability and decide whether to lend you money or not.
Your lender will in some cases also follow up on recent deposits made in your bank account. They often do this to ascertain the sources of funds. In the real sense, they are seeking to see large deposits that were made to your account and where you borrowed them from.
It is important to note that one cannot borrow funds from elsewhere to pay as a down payment or cover closing costs. For example doing so is not permitted under the mortgage loan terms and conditions.
However, money donated by family members or friends can be used as a down payment or to cover closing costs also called down payment “gift”. Besides, funds whose sources are not known (mystery money”) can mess up things during the underwriting process.
If you are not able to prove the source of funds for a recent deposit, then you could as well forget about getting the loan.
In a nutshell, lenders will need your bank statement for two main reasons. The first one is for them to know how much you earn and secondly to be able to calculate the debt-income ratio.
Why lenders look at your business tax returns
If you have ever applied for a loan either to build your home or to expand your business, then you the lender must have asked you to provide copies of your business tax returns. Did you ask yourself why they asked you to provide them? It was because they wanted to verify your income.
The lender is always interested in knowing your net worth and determine your ability to repay the loan. Tax returns give lenders a general overview of your business and how much money you make through it.
Most lenders will require that you provide tax returns for all the years you have been in business during the loan application process.
Nonetheless, the evaluation process will be dependent on the type of loan you are applying for. For instance, if you are applying for a short-term loan (with a repayment period of 18 months or less), then the lender will be less interested in your tax returns compared to your bank statement.
Types of tax returns
If you have ever filed business taxes before, then you should probably be aware of the type of tax specifically related to your business. There are different types of tax returns. They include Form 1120 (for C-Corporations), Form 1065 (for partnerships), and Form 1099-MISCs (for Limited Liability Corporation) among others.
What do lenders look for in your tax returns?
The first thing lenders look in your tax returns is income. Through tax returns, a lender will be able to see your annual returns (which is an important factor in determining whether to give you a loan or not. Most lenders will ask you to provide tax returns from several years.
The next thing lenders will ask are deductions, (sometimes known as Schedule C or your expanses). These basically include interests, payroll, benefits programs, advertising, licensing fees and depreciation.
You will then be required to minus your deductions from your total income so as to arrive at what’s referred to as taxable income.
On form 1120 and 1065, there’s a section called Schedule L – a balance sheet showing your assets and liabilities. In this section you will see information related to your loans, real estate accounts payable, shareholder equity, liabilities and your stocks. A lender will take a look at all this information for verification purposes.
If your business is a corporation filling out form 1120, you will notice a section that requires you to report on “compensation of officers”. This form is very important in the loan application process because it indicates ownership percentages.
In general, lenders always look for tax returns to acquire information such as income that will enable them to decide whether they can lend you money or not.