Loan Applications: Why Do Lenders Require So Much Paperwork?

 Loan Applications: Why Do Lenders Require So Much Paperwork?

When applying for a home loan, prospective buyers may find they must provide their lender with a mountain of paperwork, including: past statements of income, tax returns, credit, debts and additional assets. With so many documents to collect, undergoing loan processing and underwriting can be rather intimidating. Fortunately, you don't have to go it alone.

To help you get started on your loan application, here is a brief outline of all the documents you will need:

1. Pay Stubs

When applying for a loan, your lender will need proof of income. Lenders want to ensure that you have the financial means to pay off your new mortgage, as well as any other long-term debts (such as car loans) and other living expenses. They refer to this as your debt-to-income ratio.

As a result, borrowers are generally required to submit current pay stubs from the past 2-3 months. So, be sure to make copies of all these documents and keep the originals in a safe place.

For those who are self-employed, your lender may also require a little more information to help verify your source of income. Copies of your last two federal income tax returns, as well as profit-and-loss statements, may be requested for review.

2. Tax Returns and W-2s and/or 1099s

To provide further proof of employment and income, make sure to prepare copies of your last W-2 and/or 1099 statements and tax returns. Typically, lenders will ask for two years' worth of information.

Remember, a W-2 form is used by company employees. This form shows a person's income and how much money was taken out for taxes. In contrast, a 1099-MISC is used by independent contractors or the self-employed. This form shows a person's income, but does NOT show how much money was taken out for taxes.

These documents are important because they not only verify your salary, but also show trends in your earnings and details about investment gains or losses. Most importantly, this information can affect your total income level and subsequent loan approval amount, as calculated by your lender.

Does a lender absolutely need 1099s or W2s if tax returns are provided? Isn't this just a duplication of information? Ultimately, the lender is interested in the borrower's ability to afford the mortgage. Tax returns and 1099s show a history of past income, but W-2s show current income and stability of employment and wages. All these documents can be assessed against one another to ensure the numbers paint an accurate picture of your financial situation.

3. Credit Report

Before you are approved for a loan, lenders will also perform a credit check. While each loan program may have its own minimum credit score requirement, it's always smart to know your credit score in advance. So, even if you are just considering refinancing, it is never too early to check all three FICO scores to make sure that you're on the right track.

By taking this precautionary step, you have the opportunity to review your credit rating before your lender does. And, you get the chance to take care of any necessary credit repair work. This means getting rid of those extra credit cards you don't really need, paying down your account balances and making sure you pay all your bills on time from this point forward. Remember, the best mortgage rates are almost always reserved for the borrowers with the best credit.

To learn more information about how to protect your credit score, check out PennyMac's blog post, Ten Ways to Protect Your Credit Score for Mortgage Application.

4. Statements of Outstanding Debt

Even though your lender will be able to see your existing debts via your credit report, you will still have to provide documentation detailing your current outstanding financial obligations. So, make sure to gather account statements on remaining debts, including your existing mortgage, home equity lines of credit, car loans and student loans. In some circumstances, borrowers may also need to submit alimony and child support details, if applicable.

5. Statement of Assets

In addition, your lender will want to verify that you have enough cash in your savings accounts to cover any out-of-pocket closing costs and at least two months' worth of mortgage payments.

Therefore, make sure to prepare copies of statements for your saving accounts, retirement account, stocks, bonds and certificates of deposits. All of these documents will provide proof of any additional assets you own in addition to your regular salary… and may help you score a better refinance deal! Remember, the more income you have, the more a lender is willing to lend.

A Quick Review

Applying for a home loan can be rather time consuming and intimidating. But, borrowers can spare themselves some undue frustration with a little preparation. To help you along, make sure to compile the following documents before beginning processing and underwriting:

  • Pay stubs
  • W-2s and tax returns
  • Credit reports
  • Statements of outstanding debt
  • Statements of assets

And just remember, even though collecting this information is a hassle, the payoff – lower interest rates and monthly mortgage bills – may be well worth it!