Most people love to try and get their maximum tax return refund on a yearly basis and will make sure that they claim all and every deduction possible they think they qualify for. There is one deduction that you are taking that might derail your thoughts of homeownership and I bet you didn’t even know this. The deduction I am talking about is unreimbursed expenses or job-related expenses in general. These seem like such an easy deduction to take, but can cause you headaches when trying to get approved for a loan. You may want to think again when recording these expenses as a deduction, yes your tax liability decreases, but as a W-2 employee, there can be long-term adverse affects from doing this. What this deduction does is it reduces your income that is calculated when trying to get preapproved for a loan. In the following paragraphs I will go over just what happens and what the ramifications are.
Let’s start at the beginning and you are talking to an experienced loan officer like myself. You bring me your W-2s and it looks like a slam dunk that you have enough income to get that home of your dreams. However, as part of the process we will pull your tax returns, and specifically what we are looking for is Form 2106 which is the form for Employee Business Expenses. When you filed your tax returns you were probably advised to reduce your tax liability at all cost, and this is fine, but claiming those car, travel, licenses, dues, and other expenses is going to hurt your income. You are fully entitled to claiming these expenses against your Adjusted Gross Income if your employer didn’t reimburse you for them, however, banks and lending institutions don’t care about this and it will ultimately be counted against you. When a lender or loan officer looks at these 2106 expenses, they need to remove them from an annualized standpoint against your qualifying income. Since you have set the precedent that you incur unreimbursed expenses, it is assumed these expenses will keep occurring and thus will need to be removed from your income. These expenses are treated as a monthly expense and reduction of income. When you take these 2106 expenses and add that with your already occurring auto loans, student loans, credit cards, etc you are going to have an even higher DTI (debt to income) and it may disqualify you from the loan you were looking to obtain.
From a numbers standpoint, let’s look at an example of just how much these expenses can screw your pre-qualification up. For example, let’s assume you make $75,000 per year which equates to $6,250 of monthly pre-tax income earned. Normally this would be a decent amount of income to get you pre-qualified. Now let’s say you claimed $6,000 for the year in unreimbursed expenses, so if you take the monthly average, this is $500 per month of unreimbursed expenses. This means that $500 is going to come off your gross income and now your qualifying income is only $5,750. What you have essentially done is reduce your income by the amount of a car payment or more. The saving grace here is that most lending institutions will take a 2 year average of 2106 expenses and will thus use the average claimed on your last 2 tax returns. For example, if you spent $6,000 last year and only $2,000 the year before that, your expense would now only be $333 as you have claimed $8,000 over 24 months. This is $167 more favorable than just your previous year’s claim.
In counting these expenses against you, all lenders are doing is being cautious with who they are borrowing to. They want to make sure that you can indeed make your payments on the loan and if these unreimbursed expenses are going to occur, it has to be counted against your income qualifications. However, there might be a way for underwriting not to factor in these expenses if you can prove that it is not foreseeable that you will have these expenses moving forward. Who you will need to provide is a LOX (Letter of Explanation) explaining why these expenses won’t be happening moving forward and in this submission it would be smart to include any evidence supporting your claim. If you got a promotion at work or a different title that ensures a different reimbursement policy you need to make certain this is known and brought forward. If you changed jobs recently and are no longer with the employer you were claiming expenses for, this is another good reason that should pass through underwriting and not count previous expenses negatively against you.
If there isn’t a way for you to get around the unreimbursed expenses and you are set on getting a loan, just be prepared that you may not be able to afford what you thought originally. If you feel that you can’t change your price range you may need to get some of your other debt in order before you will be approved to purchase your home. You can always do the following: pay down credit card debt, pay down auto loans so there is 10 months or less outstanding (this is the time where the debt is not counted against you), put a larger down-payment, or even get a co-signer to improve the pre-approval for the home.
If you are trying to plan ahead for owning a home, you need to revisit and see if you or your tax professional claimed any unreimbursed expenses on Form 2106. As you can see, there can really be some adverse affects to having these expenses on your file when getting your pre-approval. What you have to keep in mind when filing your taxes and purchasing a home is if that extra couple hundred dollars on your return is worth more to you now than owning a home. I assume you would choose owning a home, so keep that in mind during tax season.
Working with an experienced loan officer like myself can definitely be an advantage for you as I can give you all your options to make sure we do everything we can to get you in that home of your dreams. Please reach out to me anytime at 888-900-1020, email me at firstname.lastname@example.org, or visit my website www.loanconsultants.org