Larry and Loretta tried to do everything right. They saved money so they would have a down payment for buying a house. They tried to live within their means and keep up with their credit cards and rent payments.
Then – they slipped. Despite their careful planning, they fell behind on their income taxes. As they tried to correct that mistake, a home became available in their ideal neighborhood. It was just the situation they were saving for. But now there was an unexpected but critical question:
Even if you owe taxes, you can still purchase a home, but obtaining a mortgage will be more difficult until your tax situation is rectified. Buying a house is complicated at the best of times. If the IRS is involved, complications multiply quickly.
The IRS may enroll you in a payment plan if you owe money to the government for overdue taxes. Alternatively, it might put a tax lien on all of your belongings, including your house, informing any potential buyers that the IRS will receive payment first if the property is sold. Anything that affects your financial health and flexibility can also affect your chances of getting a mortgage.
The first step in resolving your tax debt is to work with the IRS, whether or not you’re trying to purchase a home. Banks and other lenders are more likely to consider your mortgage application favorably once you are enrolled in a program to pay off your tax debt.
If you’ve always wanted to buy a house but are deterred by tax debt, don’t give up! Although having debt to the IRS can make the process more difficult, it doesn’t mean that your dream will never come true. Even if you have an outstanding tax bill, you can still become a homeowner with cautious planning and proactive measures.
Understanding the IRS Debt Landscape: Delinquent Tax Debt vs Tax Lien
Before diving into the specifics, let’s differentiate between delinquent tax debt and a tax lien Delinquent tax debt simply means you haven’t paid your taxes in full, while a tax lien is a more serious situation where the IRS places a legal claim on your property due to unpaid taxes
Navigating the Mortgage Maze with Tax Debt: Your Options
1. Pay Off Your Tax Debt: The most straightforward approach is to pay off your tax debt in full before applying for a mortgage. This eliminates the debt as a potential hurdle and simplifies the loan approval process.
2. Set Up an IRS Payment Plan: If paying off the debt in one go isn’t feasible, consider setting up a payment plan with the IRS. This demonstrates your commitment to resolving the debt and may make lenders more comfortable approving your loan. Remember, your monthly payment plan should fit within your budget and not exceed the 45% debt-to-income ratio threshold most lenders require.
3. Prepare for the Repercussions of Ignoring the Debt: Ignoring your tax debt can result in a tax lien, which makes the home-buying process much more difficult. Because it impacts their claim to the property, lenders are reluctant to approve mortgages when there is a tax lien in place.
The Impact of Tax Debt on Different Loan Types:
Conventional Loans: These loans are typically stricter, requiring higher credit scores and larger down payments. A tax lien can make securing a conventional loan challenging, but a payment plan can increase your chances of approval.
FHA Loans: With regard to credit scores and down payments, these government-backed loans are more forgiving. To be eligible, though, you must have an IRS payment plan in place and have made at least three payments in a row.
VA Loans: These loans are available to eligible veterans and active-duty military personnel. Even though a tax lien can be difficult, having a payment plan can increase your chances of getting approved.
The Importance of Transparency and Professional Guidance:
Honesty is key! Be upfront with your lender about your tax debt and payment plan. This allows them to assess your financial situation accurately and determine your eligibility. Seeking guidance from a tax professional or experienced mortgage broker can provide valuable insights and help you navigate the complexities of buying a house with tax debt.
Additional Considerations:
State Tax Debt: Just like federal tax debt, state tax debt can also impact your home buying journey. Having a payment plan in place with the relevant state authority can increase your chances of securing a mortgage.
Refinancing or Selling a Property with a Tax Lien: Refinancing or selling a property with a tax lien can be challenging. It might be necessary to pay off the lien first with the proceeds from the sale or refinance. Consult with a tax professional to explore options like lien discharge or subordination.
Remember, owning a home is a significant financial commitment. Ensure you can comfortably manage your mortgage payments alongside your tax debt obligations.
By following these tips and taking proactive steps, you can increase your chances of achieving homeownership even with tax debt. Don’t let tax debt deter you from pursuing your dream!
Additional Resources:
- IRS Website: https://www.irs.gov/
- National Foundation for Credit Counseling: https://www.nfcc.org/
- HUD Homeownership Resources: https://www.hud.gov/topics/homeownership
How Lenders Discover Your Tax Debts
For most of us, buying a home is the largest transaction we’ll ever make. Thus, it stands to reason that the application and approval process for a home loan is the most rigorously scrutinized we’ll ever be.
Lenders base their decisions largely on risk. Does the applicant have the resources or income to repay the loan? Has the applicant paid off previous loans or debts on time? Does the applicant have any other issues that might make it difficult for them to make payments?
Tax debts and liens are just such problems. They appear in your credit report, which is carefully screened by potential lenders. The existence of tax debts, liens, and unfiled taxes will also be visible there because lenders need to verify your income and financial information by obtaining your most recent tax returns.
Lenders also search public records for information about applicants. Tax liens often turn up on such searches. If nothing else, public records can confirm information obtained from tax returns and credit reports.
Understanding Your Situation: Tax Liens vs. Tax Debts
You have a tax debt as soon as you don’t file your taxes or pay the taxes that are due on time. It is feasible—in fact, advised—to settle that debt as soon as possible by collaborating with the IRS or the state tax authority.
If that’s not possible, the IRS can place a lien on your property. That means the IRS has control over the property. It can block activity, including selling the property, until it receives the money it is owed. Additionally, it implies that the lien will appear on your personal credit report, seriously harm your credit score, and have an impact on your future loan applications.
A tax debt can have an impact on your ability to get a mortgage. A tax lien will almost certainly complicate the process.
Recall that the purpose of a lender’s evaluation of a mortgage application is to determine whether or not the potential home buyer presents a good risk. Will they be responsible and make their monthly payments on time?.
A tax debt raises red flags for lenders because it indicates that the applicant has not been financially responsible. A tax lien is a more serious warning indication that the careless actions have resulted in legal ramifications.