With the extension of credit, lenders and creditors want to feel confident that you have adequate income to take on new or additional debt.
One of the ways that lenders verify your income is by reviewing your annual federal income tax returns. Administered by the Internal Revenue Service (IRS), income taxes are imposed on people living in the U.S. more than 180 days a year. As such, the IRS considers you a resident and the money you make in the U.S. is fully taxable. (You can obtain a tax identification number even if you do not have a Social Security number from the IRS. A tax identification number will serve as a way to record your income and file a tax return.)
If you work for an employer, a certain portion of your pay will be subject to “withholding” and be remitted directly to the federal and state governments before you receive your paycheck. If you work for yourself, you are expected to make estimated tax payments in advance to the IRS and state tax department on a quarterly basis.
On April 15 each year, you are required to file a tax return with the IRS for the previous year. The return will list your income and any allowable deductions or credits against that income. Once calculated, you will either owe more money in taxes or you will get a refund made up of the surplus tax dollars that you paid.
Note: If you earn a low or moderate annual income, you may qualify for a special tax benefit administered by the IRS. Known as the Earned Income Tax Credit (EITC), it is the largest federal aid program targeted to people with low-and moderate-incomes. Millions of taxpayers currently benefit from the tax credit annually yet many people who are eligible don't know it exists, how to qualify, or how to claim it.
People who qualify for EITC and file a federal tax return can get back some or all of the federal income tax that was taken out of their pay during the year. They may also get cash back from the IRS. Even people whose earnings are too small to owe income tax can get the EITC. For more information, contact the IRS 24-hour information line at 800-TAX-1040 or visit http://www.irs.gov/.
If you do not file income taxes in the U.S., begin doing so right away. It is an important way for lenders to document your income and income history so that you can obtain a loan or mortgage on a home. And, if you file your annual tax returns and end up qualifying for a refund, it will certainly brighten your day.
More on having sufficient income . . .
Who would you be more likely to loan money to?
- Your friend who is without income and has no ability to pay you back?
- Your friend who is working and has enough money left over to pay you back?
Lenders, especially in the case of mortgage lenders, will carefully consider debt-to-income “ratios.” Debt-to-income ratios are calculations or percentages of the amount of your gross monthly income that may be paid for monthly debts.
For example, a typical home mortgage qualifying ratio is 28/36. This means that no more than 28% of your gross monthly income can be used to pay for your principal, interest, property taxes, and insurance (PITI). Furthermore, no more than 36% of your gross monthly income can be used to pay for your PITI and other monthly debts. (Lenders consider your monthly debts as the amounts you owe on your loans and credit cards. Lenders do not require you to disclose the amount of any financial obligations you send back on a monthly basis to relatives who live in another country. However, it’s wise for you to consider these monthly remittances as part of your overall debt so that you can afford and be comfortable with your monthly mortgage payments over the long-term.)
It is also important to note that in addition to PITI, homebuyers who pay less than 20% down may be required to purchase mortgage insurance.
