What is a 4506-T Used For?

In the good old days of the housing boom, many lenders simply took a mortgage applicant's word concerning annual earnings. After the economy turned south it as discovered that many of the defaulting borrowers had grossly overestimated their salaries to qualify for loans they could not (obviously) afford. There is little point in trying to apportion blame for these so-called liar loans, as everyone from sellers and buyers to lenders and government agencies were prancing happily down the road to the American Dream of Homes for Everyone. It was a dream, however, that turned into something of a nightmare.

To prevent a recurrence of these liar loans, mortgage applicants now are asked to sign an IRS form, namely Form 4506-T, to authorize the release of up to four years of tax returns (as electronic transcripts) to the loan officer. Other financial institutions, and even mortgage investors, can request you to do the same, as well. This is not a brand-new occurrence, the release of IRS return data, but it is different in one crucial way, in that the transcripts are supplied at two times during the application process, and not simply at the close of escrow when it won't matter much.

Historic reasons
The return information was never requested as a matter of course on all applicants, but primarily for those with red flags in their profile like self-employed persons. Now the government mortgage guarantor, Fannie Mae, wants lenders to get two sets of the transcripts on borrowers, irrespective of their sources of income. One would be obtained at the start of the lending process, another at closing. The object, of course, is to throw the widest possible net to capture fraudulent claims of income, thus limiting future loan losses.

At the peak of the housing market boom, simply stating one's income was sufficient in most cases, and these no-documentation type loans became the norm. Although precise figures are hard to come by, the number of foreclosures suggests that the no-doc loans, filled with inflated income figures, are a large portion of the problem that is observed across the nation, that is, abandoned homes at record levels.

Government-lender partnership
Since the IRS is not allowed by law to make a profit on such services as income checks, it pegs to price the 4506-T transcript service at its actual cost. Because the mandated income checks (two for each borrower, remember?) have increased the transcript business, economies of scale have kicked in to reduce the cost from .50 to .25 per transcript. The cooperation among these private and government groups is intended to make the loan application process more honest, more open and more rooted in fact that fiction. Overall, the requirement for 4506-T forms seems a reasonable thing.

The transcript cost reduction couldn't have happened at a better time for lenders, who are already motivated to return to saner, safer and more accurate methods for granting loans. It is good for the government, too, as the insurer of last resort (sometimes first and last) for U.S. mortgages. However, even as you contemplate signing a 4506-T form in your current home buying situation, you need to know a few things about the process. There are ways the information you are releasing can be misused, and you must be aware of exactly what is happening.

Serious business
Form 4506-T, being a powerful tool for revealing your intimate financial details, can expose that information to an unknown number of people, and a number that is impossible for you to control after signing. It may be the most important thing you sign, so you read and understand it. Make sure to read the IRS's own form instructions, and pay attention to the years being requested as well as the dating of the form. The date is important because the IRS must receive the form without 60 days of its signing. You should date the form yourself, and not turn it in undated.

Checking the tax return years being requested allows you to reduce the number from the maximum, which the lender may have filled in for you. It is not necessary that the maximum number of years of transcripts be obtained in every case, and you should question anything that is filled in on the form before you even see it. The bottom line is, Form 4506-T is now something you will see twice if you are getting a home loan. For your own good you must know how it's used, and how it's abused. You can read further on the subject (and it's recommended if you're in the market for a home), and download a copy from the IRS Web site (irs.gov) to study on your own. Forewarned, of course, is forearmed.