Why Do Mortgage Lenders Need Bank Statements & Tax Returns?

When you apply for a mortgage loan, your lender will probably request copies of your two most recent bank statements, along with your tax returns for the past two years.

These are some of the most commonly requested documents during the home loan application process, and for good reason.

Bank statements and tax returns help the lender verify your income, assess your financial stability, measure the level of risk, check for potential fraud, and more.

Why Mortgage Lenders Need Bank Statements

When you submit a mortgage loan application, the mortgage lender will want to know everything about your current financial situation. Among other things, they want to know how much money you have in the bank and how long it has been in there. This is known as asset verification.

Here are the main reasons why lenders want to see your bank statements:

• Income Verification: They use these documents to verify the information you provided within the mortgage application, including your income and employment status. By verifying regular deposits and paychecks, the lender can determine how much money is coming in.
• Asset Verification: The lender also wants to make sure you have enough money in the bank to cover the minimum down payment, closing costs, and any additional cash reserves that might be required.
• Debt Obligations: They’ll look for any recurring payments that might affect your ability to repay the mortgage, including loan payments, credit card bills, or other financial commitments.
• Financial Responsibility: The lender will assess your overall financial habits, which includes spending patterns, the ability to save, and how well you manage your money.
• Fraud Detection: Bank statements can also reveal unusual activity that might indicate fraud, such as large deposits or withdrawals from unknown sources.

As you can see, bank statements help mortgage lenders check off a lot of boxes. It’s like the financial document equivalent of a Swiss Army knife.

Information Included Within Bank Statements

Bank statements are not standardized across the banking industry. So they can vary from one bank or credit union to the next. But they generally include the following types of information.

A typical bank statement includes the following information:

• Personal Information: Account holder’s name and address, account number, and statement period (usually one month).
• Account Summary: Beginning balance, ending balance, total deposits and credits, total withdrawals and debits.
• Transaction Details: Date, amount, and description for each transaction (e.g., check, deposit, ATM withdrawal, transfer, etc.) along with a running balance after each transaction.
• Interest and Fees: Any interest earned, monthly service fees applied, other fees and charges like overdraft or ATM fees.

As for timing, mortgage lenders usually review bank statements as part of the mortgage underwriting process. Underwriting takes place after your purchase offer has been accepted by the seller but before the final closing.

But some lenders might want to see your bank statements earlier in the process, during the pre-approval stage that happens prior to house hunting. The timing can vary due to different business practices and other factors.

Sourcing the Down Payment Funds

Lenders also review banking documents to identify the source of all recent deposits. They want to determine where the money that’s being used for the down payment came from.

In the mortgage industry, this is commonly referred to as “sourcing.”

Mainly, the lender wants to know that you’ve personally accumulated the down payment funds, or obtained them through some other approved source such as a third-party donation.

Some mortgage programs prohibit borrowers from taking out a loan to cover the minimum required investment (a.k.a., down payment). So they’ll review bank statements and source all funds to determine whether or not this has occurred.

To be clear: Most mortgage programs allow borrowers to use “gift money” that was donated from an approved source, such as a family member or close friend. But using a personal loan to cover the down payment might be prohibited under your mortgage program. These are two different things.

In summary: Mortgage lenders look at your bank statements to see how much you’re earning, to calculate your debt-to-income ratio, to verify assets and down payment funds, and to assess risk.

Why They Look at Your Tax Returns

When you apply for a home loan, the lender will also request your tax returns for the past one to two years. Mainly, they do this to verify your income. But there are other reasons as well.

While recent bank statements help the lender verify your income and assets, tax returns allow them to review your long-term financial situation.

Here are some of the main reasons why mortgage lenders look at tax returns:

• Income Verification: Federal income tax returns provide the most accurate and detailed record of a borrower’s income. Mortgage lenders verify all sources of income, including salary or wages, bonuses, investments, rental income, etc.
• Financial Stability: Mortgage lenders also use tax returns to check for income stability and consistency over time. This helps them assess your ability to repay the loan over the long term. Stable income is important for all borrowers but especially those who are self-employed.
• Additional Income Sources: Tax returns help lenders identify all sources of income that might be used for mortgage qualification purposes. This can include investments, rental income, alimony, child support, and more. All of these contribute to the borrower’s ability to repay the loan.

Typically, lenders will request one to two years’ worth of federal tax returns. But self-employed borrowers and those with more complex financial situations might have to provide additional years.

The review of tax returns typically occurs during the underwriting process. The underwriter will review a wide range of documents, including bank statements, pay stubs, credit reports and more. They do this to ensure the borrower meets all applicable guidelines and also to assess the level of risk.

Information Contained Within Tax Returns

Federal income tax returns provide a lot of detailed information that’s relevant for mortgage lenders. But they primarily focus on the following items when reviewing these documents:

• Income Sources: This can include W-2 wages for traditionally employed individuals, Schedule B showing interest and dividends, Schedule C for self-employed borrowers, Schedule E for rental income, etc.
• Adjustments to Income: These are specific deductions that reduce the applicant’s adjusted gross income (AGI). Lenders consider these adjustments when calculating the borrower’s overall income for qualification purposes.
• Taxable Income: This is the income that taxes are based on after any deductions and exemptions. Lenders use this figure to determine the borrower’s ability to repay the loan.
• Credits and Deductions: While these don’t directly impact the income used for mortgage qualification, the lender might use them to assess the borrower’s overall financial situation and tax burden.
• Filing Status: The applicant’s filing status (single, married filing jointly, head of household, etc.) can affect their tax liability and disposable income.
• Dependents: The number of dependents claimed on the tax return can also influence the borrower’s financial situation and expenses.

5 Things You Should Take Away From This Guide

We’ve covered a lot of important information in this guide. So let’s summarize the highlights. Here are the five most important points you should take away from this:

1. Mortgage lenders review bank statements for a variety of reasons.
2. They do this to verify income and assets, and also to reduce risk.
3. It shows if you have the funds for a down payment and closing costs.
4. They usually want to see statements for the past two months.
5. They look at tax returns for similar reasons, but over a longer period.

Disclaimer: The mortgage application and underwriting process can vary from one borrower to the next for a variety of reasons. Because of this, portions of this guide might not apply to your particular situation.