Buying a home is an exciting milestone. However having outstanding debt to the IRS can throw a wrench in the process. Many homebuyers wonder – can I get a mortgage if I owe back taxes?
The short answer is yes, you can still get approved for a home loan even if you owe taxes. However, there are a few caveats.
How Mortgage Lenders View Tax Debt
Mortgage lenders will dig deep into your finances before approving you for a home loan. They want to ensure borrowers can afford their monthly payments. Tax debt is one liability lenders will uncover.
Lenders view owed taxes similarly to other debts like credit cards or student loans. The main difference is that IRS debt can’t be discharged through bankruptcy.
Outstanding taxes do not automatically disqualify you from a mortgage. Instead, lenders will want to see
- You are making regular payments through an IRS installment agreement
- Monthly payments fit within debt-to-income (DTI) requirements
- You can still meet down payment and reserve requirements
As long as your IRS payment plan does not eat up too much of your take-home pay, loan approval is possible
Impact of Tax Liens on Mortgage Approval
Tax liens can make getting a mortgage more challenging. A federal tax lien gives the IRS the legal right to your property if the debt remains unpaid.
Lenders view open tax liens as a major red flag. The presence of a lien makes it riskier for banks to lend. Before issuing a mortgage, most lenders will require federal and state tax liens to be paid off.
You have options if you can’t immediately pay off a tax lien:
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Apply with a lender who accepts tax lien subordination – Some lenders will let you keep IRS and state liens in place if you make monthly payments. The lien holders must agree to collect only after the mortgage lender if you default.
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Attempt partial settlement – You may be able to negotiate a partial payment plan with the IRS to partially satisfy a tax lien. This can reopen mortgage options.
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Dispute the lien – You can challenge the legitimacy of a tax lien by requesting a Collection Due Process hearing. This may lead to the withdrawal of the lien until the dispute is settled.
Steps to Improve Home Loan Chances with IRS Debt
If you currently owe back taxes, take these steps to preserve mortgage eligibility:
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Set up an IRS installment plan – Monthly payments to the IRS show lenders you are committed to repaying your tax debt. Online payment plans are easy to establish on IRS.gov.
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Pay down balances – Work to pay down credit cards and other debts to maximize your options. Lenders will check your total monthly obligations.
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Save for a down payment – Down payments as low as 3% may be allowed, but 20% down is ideal. Big down payments lower lender risk.
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Check credit reports – Make sure no errors or outdated tax liens appear on your credit. Dispute any errors.
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Talk to a tax professional – They can help you determine the best options based on your situation. A CPA or Enrolled Agent can assist with tax resolution.
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Consult lenders – Discuss your unique scenario with mortgage officers to see what tax repayment plans may satisfy their underwriting requirements. Many have experience with IRS debt.
As long as you keep making on-time payments to the IRS, a record of regular repayment will show lenders you take the debt seriously.
Applying for a Mortgage with Back Taxes Owed
Here are some tips for navigating the mortgage process if you have outstanding IRS debt:
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Disclose upfront – Let your loan officer know about any payment plans or liens early in the process. Never try to hide owed taxes.
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Gather tax documents – Lenders will request the most recent tax returns, IRS installment agreement terms, and evidence you are current on payments.
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Get pre-approved – This gives you a better idea of your chances before you start seriously house hunting. Pre-approval considers your total financial picture.
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Know your DTI – Your total monthly debt payments divided by gross monthly income must stay under lender limits, often 45%. Factor in IRS installment payments.
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Build your savings – The more you have for a down payment and closing costs, the better. Shoot for 20% down if possible.
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Consider loan types – FHA loans allow more flexibility with credit issues than conventional mortgages. VA home loans work with IRS repayment programs.
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Pick loan term wisely – Shorter terms mean higher monthly payments. Make sure payments align with your budget and DTI limits.
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Have co-borrowers – Adding an applicant with better credit and finances can improve your odds. Income and debts are combined.
Stay up to date on payments while going through the mortgage process. On-time monthly payments are critical for approval. Let your tax professional handle any negotiations with the IRS.
Options for Home Buyers with Tax Issues
If your tax debt makes mortgage approval unlikely, you still have alternatives:
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Ask sellers to finance – Seller financing works like a purchase-money mortgage. The seller acts as the bank, and you repay them over time.
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Lease to own – Rent a home for 1-3 years, then purchase it when your tax issues are resolved. Part of the rent goes toward a future down payment.
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Purchase through a trust – Property can be acquired under an irrevocable living trust or land trust. Consult an attorney or CPA to set up properly.
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Rent – Bide your time as a renter until back taxes are paid off. Save up for a larger down payment in the meantime.
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Improve credit – Pay all current bills on time and pay down balances. Maintaining good credit helps you qualify when taxes are paid.
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Ask family to co-sign – A relative with good credit may be willing to co-sign the mortgage and help you buy. Make sure they know the risks involved.
With persistence and focus on repaying the IRS, homeownership is not out of reach. Come up with a tax resolution plan, stick to it, and monitor your credit. Your chances of a mortgage approval will steadily improve over time.
FAQs: Home Loans and Owed Taxes
How long after paying off back taxes can you buy a house?
It’s ideal to have at least 12 months of on-time payments to the IRS through an installment plan. Paying off a tax lien can allow approval quicker since the lien release removes the property encumbrance.
Can you buy a house if you are on a payment plan with the IRS?
Yes, lenders will approve mortgages with an IRS payment plan as long as the monthly amounts fit within your budget. Make sure to document the plan terms and stay current on payments.
Do mortgage lenders check if you owe taxes?
Yes, it is standard practice for lenders to review federal tax transcripts provided directly from the IRS. Any balance due will be uncovered, even if you already have a repayment plan.
What credit score do you need to buy a house with tax debt?
Requirements vary by lender, but credit scores above 620 have the best approval odds. Good credit helps offset tax repayment obligations. An ideal score is over 740.
Can I remove a tax lien from my credit report?
No, tax liens remain on your credit report even after they are paid. The only way to remove a lien is to dispute it if you believe it was filed in error. If valid, the tax lien history will continue to show.
Do I have to pay off old taxes to refinance my house?
In most cases, yes. Lenders want all IRS tax debt resolved before approving a refinance to lower risk. An exception may be lien subordination programs that allow debt to remain.
Can the IRS take my house if I owe back taxes?
The IRS can seize and sell your home if you fail to repay tax debt. They must properly file a tax lien first. Setting up an IRS payment plan can prevent tax debt from rising to the level of enforcement.
Key Takeaways – Mortgages When Owing Taxes
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Outstanding taxes do not automatically disqualify you from getting a home loan if you stay current on IRS payment plan.
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Federal tax liens will need to be satisfied before closing for most lenders.
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Your total monthly debt payments, including IRS installment agreement, must stay within lender DTI limits.
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Work to pay down other debts and maintain positive payment histories to improve mortgage eligibility.
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Allow extra time and document your IRS repayment status early in the home buying process.
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Seller financing, lease to own arrangements, or co-borrowers can aid approval if your tax issues limit traditional mortgage options.
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Continuing to pay the IRS on-time even after being declined shows lenders you are committed to resolving tax debts.
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Other Ways a Tax Lien Affects Buying a House
Besides affecting your ability to secure a mortgage, a tax lien can also affect other facets of the home buying process. For instance, a tax lien can cause difficulty in securing home insurance—a requirement for most mortgages. Also, you may face challenges when trying to sell the home later, as any proceeds from the sale might be used to pay off the tax lien first.
Furthermore, a tax lien can limit your options when seeking other forms of credit necessary for homeownership, such as home improvement loans or lines of credit. With a tax lien affecting your credit score, obtaining these could be challenging.
Even after the lien is resolved, its impact can still linger. Credit bureaus may keep tax liens on credit reports for seven years from the date of payment, affecting your ability to secure favorable interest rates long after the tax issues are resolved.
How Tax Debt Affects Mortgage Approval
Mortgage lenders take on a considerable amount of risk when they approve a home loan, and they evaluate an applicant’s financial profile carefully to ensure they can meet the monthly payments. When you apply to get a mortgage, the lender will examine your financial standing, including any outstanding debts, tax debt, and, of course, any federal tax lien. They will also look to see if you owe tax debt to a state as well as at your IRS tax bill.
Lenders often consider tax debt as a negative mark on your creditworthiness, mainly because it indicates a history of financial irresponsibility or hardship. This can affect your debt to income ratio, a key factor in the loan approval process. This ratio compares your monthly debt payments to your gross monthly income. If you owe a substantial amount of tax debt, your debt to income ratio might exceed what most lenders are comfortable with, complicating your mortgage approval process.
The type of mortgage also matters. For instance, if you’re applying for a conventional loan, you might face stricter requirements. Conventional loans are usually issued by private lenders, and they often have stricter credit score and debt-to-income ratio requirements than government-backed loans, such as FHA loans or VA loans.