If you’re planning to buy a home in the near future, one of the most important steps to take before you start house hunting is to ensure that your taxes are in order. Your tax returns play a crucial role in the mortgage approval process, and filing them correctly and on time can make the home-buying journey much smoother. Here’s why filing your taxes is essential when buying a home and how it can affect your ability to secure a mortgage.

1. Lenders Require Recent Tax Returns

When you apply for a mortgage, lenders typically ask for your most recent two years of tax returns. These documents help the lender verify your income, ensure that you’re financially stable, and assess your ability to repay the loan. If you haven’t filed your taxes, or if there are discrepancies in your tax returns, this can create red flags for the lender and potentially delay or derail your home-buying process.

Here’s why tax returns are so important:

• Proof of income: Lenders use your tax returns to verify how much money you make. This is especially important if you’re self-employed, work freelance, or earn income from multiple sources. For W-2 employees, lenders may also ask for recent pay stubs and employment verification letters, but your tax returns give the most complete picture of your financial history.
• Debt-to-income ratio (DTI): Lenders use your income, as reported on your tax returns, to calculate your debt-to-income ratio—the percentage of your income that goes toward paying your debts each month. A lower DTI makes you a more attractive borrower, and filing your taxes accurately helps ensure that your income is properly documented.
• Tax liabilities: If you owe back taxes, this can impact your ability to get approved for a mortgage. Lenders want to see that you’re current on your financial obligations, and unpaid tax debt can be a sign of financial instability. Before applying for a mortgage, make sure any outstanding tax liabilities are resolved, or set up a payment plan with the IRS.

2. Tax Deductions and Credits Can Boost Your Savings

Filing your taxes before buying a home not only helps with the mortgage approval process, but it can also maximize your savings. If you qualify for tax deductions or credits, such as the Earned Income Tax Credit (EITC) or deductions for student loan interest, it can reduce your taxable income, which means more money in your pocket. These savings can go toward your down payment, closing costs, or other home-buying expenses.

Additionally, if you’re already a homeowner or are buying a second home, certain tax deductions related to homeownership can reduce your overall tax burden:

• Mortgage interest deduction: You can deduct interest paid on the first $750,000 of your mortgage loan.
• Property tax deduction: You can deduct state and local property taxes up to $10,000.
• Energy-efficient home improvements: If you make eligible energy-saving improvements (such as installing solar panels), you may qualify for tax credits that lower your tax bill.

Filing your taxes ensures you claim these benefits and keep more of your money as you prepare to buy a home.

3. Filing Taxes Shows Financial Responsibility

Lenders want to see that you are financially responsible, and being up to date on your taxes is a key part of that. If you haven’t filed your taxes, or if your tax returns show large amounts of unreported income or deductions that don’t make sense, lenders may be hesitant to approve your mortgage application. In fact, not filing taxes can raise red flags and lead to the lender declining your mortgage request altogether.

Here’s how filing your taxes demonstrates responsibility:

• Transparency: Filing on time and accurately shows that you’re being honest about your finances.
• Financial discipline: A clean tax filing history shows that you’re staying on top of your obligations, which reassures lenders that you’ll be able to handle a mortgage responsibly.

If you’ve missed filing previous years’ taxes, or if you have unresolved issues with the IRS, it’s important to address these concerns before you begin the home-buying process.

4. Self-Employed? Your Tax Returns Are Even More Important

If you’re self-employed or a gig worker, your tax returns are crucial for proving your income. Unlike W-2 employees, who can easily show their earnings through pay stubs, self-employed individuals rely on their tax returns as the primary document for verifying income. If you haven’t filed, or if your tax returns show inconsistent or low income, getting approved for a mortgage can be more difficult.

Here are some tips for self-employed buyers:

• Report all income: Be sure to report all of your business income on your tax returns. Underreporting income may reduce your tax bill, but it can hurt your chances of qualifying for a mortgage since lenders base your loan amount on your reported earnings.
• Track deductible expenses carefully: While deductions for business expenses can reduce your taxable income, they may also lower the amount of income lenders consider when reviewing your mortgage application. Be strategic about claiming deductions, especially in the years leading up to your home purchase.
• Use tax forms as proof: Lenders may ask for additional documentation, such as IRS Form 1099 (for contractors) or Schedule C (for sole proprietors), so keep these records organized when filing your taxes.

5. Tax Refund? Use It Toward Your Down Payment

If you’re expecting a tax refund, this can be a great way to boost your home-buying savings. Consider using your tax refund to cover part of your down payment, closing costs, or even as a reserve fund for home-related expenses like moving or renovations. Many first-time homebuyers struggle to save enough for a down payment, so using your tax refund wisely can help you reach your goal sooner.

Here are some ways to use your tax refund when buying a home:

• Increase your down payment: The more you can put down upfront, the better your mortgage terms may be. A larger down payment could mean a lower interest rate or reduced mortgage insurance premiums.
• Cover closing costs: Closing costs can be a significant expense, typically ranging from 2% to 5% of the home’s purchase price. Your tax refund can help cover these fees and make the home-buying process smoother.
• Build an emergency fund: Having a savings cushion after buying a home is essential for unexpected repairs, maintenance, or even temporary job loss. Use your tax refund to build an emergency fund to cover 3-6 months of living expenses.

Conclusion

Filing your taxes before buying a home is a critical step in the home-buying process. Not only do lenders require tax returns to verify your income, but filing your taxes can also help you take advantage of deductions and credits that boost your savings. Whether you’re a traditional employee or self-employed, having your taxes in order will make the mortgage application process easier and set you up for success as a new homeowner. So yes, if you’re planning to buy a home, make sure your taxes are filed—and done right!