If You Owe Taxes Can You Buy a House?
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:
Can you buy a house if you owe taxes?
You can buy a home if you owe taxes, but the process of getting a mortgage will be more complicated until your tax situation is resolved. Buying a house is complicated at the best of times. If the IRS is involved, complications multiply quickly.
If you owe the government back taxes, the IRS can put you In a payment program to pay off your tax debts. Or, it could place a tax lien on all of your property, including your home, which tells all other creditors that the IRS gets paid first if the property is sold. Anything that affects your financial health and flexibility can also affect your chances of getting a mortgage.
Whether you’re trying to buy a house or not, the first thing to do is cooperate with the IRS in settling your tax debt. Once you are in a program to resolve your tax debt, banks and other lenders are more likely to look favorably on your mortgage application.
Understanding Your Situation: Tax Liens vs. Tax Debts
The moment you fail to file your taxes or pay owed taxes on time, you have a tax debt. It is possible, even advisable, to resolve that debt as quickly as possible by working with the IRS or your state tax administration.
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. It also means the lien will show up on your personal credit report, do severe damage to your credit score and affect your attempts to get a loan in the future.
A tax debt can have an impact on your ability to get a mortgage. A tax lien will almost certainly complicate the process.
Remember, when a lender is evaluating a mortgage application, its goal is to find out whether the prospective home buyer is a good risk. Will they be responsible and make their monthly payments on time?
A tax debt is a red flag to a lender, a sign that the applicant has not been responsible in financial matters. A tax lien is a bigger red flag, a sign that the irresponsible behavior has led to legal consequences.
The Impact of Tax Debt on Securing a Mortgage
When you apply for a mortgage, the lender looks at all available information about you, and there is plenty to consider. Owing tax debt can raise questions about whether you are a good risk who is likely to make monthly mortgage payments on time.
But there is more. The lender looks at your credit score and weighs your debt-to-income ratio – basically, how much you owe compared to how much you earn. A tax debt negatively affects both of those metrics. It can hurt your credit score and add debt without helping your income.
Your first step should be addressing your tax debt directly with the IRS or your state government. Responsible handling of a significant financial matter is a good sign to a lender. There are good options for settling your tax debts.
To a lender, debt you are actively paying down looks much better than debt that is unaddressed and perhaps leading to a tax lien.
The Impact of Tax Liens on Securing a Mortgage
A tax lien has a significant impact on securing a mortgage because a tax lien has a significant impact on pretty much every part of your financial life. Tax liens become a part of your credit report, which is one of the primary resources for lenders evaluating your eligibility for mortgages, car loans and other forms of credit.
A low credit rating, regardless of the reason, is a significant hurdle in the mortgage process. Information on credit reports, including tax liens, is available to every potential lender or issuer of credit. Also, remember that a mortgage lender may require several years of tax returns, which means information about your tax situation will be on view.
Just as important, a tax lien doesn’t just remain on your older property. If you purchase a new home, the lien is attached to the new home, as well. This can affect your ability to obtain mortgage insurance, which is usually a requirement of getting a mortgage. To a lender, the lien means the government has claims on the property that take precedence over the lender’s claims. So if you fall behind on your mortgage payments, the lender can’t simply repossess the house. The IRS may already have it.
Don’t give up! One way to lessen or remove the impact of a tax lien is obviously to pay the tax debt and have the lien removed. But it’s also possible to improve your chances without erasing the entire debt. You may be able to negotiate with the IRS or state agency to have the lien removed. Setting up a payment plan with the IRS is another way to signal to potential lenders that you are a responsible candidate for a loan.
Begin addressing your debt or lien before applying for a mortgage, if possible. A lender may want to see that payments have been made for three months to a year before approving a mortgage.
The Effect of Owing Taxes on Various Home Loan Types
There are several types of mortgage loans. Most of the advice about trying to buy a home while owing a tax debt applies across the board with each loan type.
But it is worth noting the differences between various types of home loans.
Impact on FHA Loans
The Federal Housing Administration provides mortgage insurance on loans made by FHA-approved lenders. These loans are popular with first-time homebuyers or those with low credit scores. They can come with lower down payment requirements and more lenient credit score standards. The federal government backs the loan, which gives lenders more security if they approve a loan.
The FHA factors this into the approval process. It also has clearly defined guidelines for applicants with delinquent federal tax debt. The applicant must either:
- Have entered into a valid repayment agreement with the Internal Revenue Service and made at least three months’ worth of timely payments, or
- Have received permission from the IRS to delay payment on the tax debt.
The lender, which is approved by the FHA, must verify that one of these conditions is met during the underwriting process for the loan. This may not be easy for the homebuyer to do, but at least there is a clear blueprint for success.
Impact on VA Loans
The Veterans Administration provides a number of benefits for those who serve in America’s armed forces. A significant benefit is the VA loan program. A VA-backed mortgage allows veterans and active military to buy a home without a down payment, without private mortgage insurance and with limited closing costs.
Can you get a VA loan with a tax debt or lien? It is possible, although back taxes can affect the overall amount of your loan. Your repayment amount would be included in your debt-to-income ratio, an important measuring stick for lenders. A high DTI ratio could mean you’re approved for a lower loan amount.
As with FHA mortgages, your best strategy is to agree to a structured program to address your debt and to adhere carefully to that program. Making payments for 12 months shows potential lenders that you are financially responsible.
It helps to have financial resources, including other property, which allow you to pay off your tax debts.
On Page 4 of the Uniform Residential Loan Application, you need to indicate that you have an outstanding tax lien. That would likely trigger a “manual underwrite,” which is a more involved process that comes with tighter credit, income, and debt requirements.
Impact on Conventional Loans
Conventional loans are mortgages that are not guaranteed or backed by the federal government. They are governed by the free market and can be more challenging to qualify for. They generally require higher credit scores and larger down payments.
Lenders in this environment, without FHA or VA backing, are more likely to deny an applicant with a tax lien. The lender sees a significant risk because a lien shows the borrower has defaulted on a federal debt. The lien also gives the government the power to seize the property, removing the lender’s most effective leverage in dealing with a default.
Nevertheless, there is still hope for obtaining a conventional mortgage despite a tax lien. If the lender has worked with the IRS to address the debt and has demonstrated ability and willingness to adhere to a repayment program, a lender may evaluate the application more favorably.
If the borrower has other property that is not under a lien, the lender may view that as secure collateral for a new loan.
How Lenders Discover Your Tax Debts
For most of us, buying a home is the largest transaction we’ll ever make. It makes sense, then, that the process of applying for and obtaining a home loan is the most thoroughly vetted we’ll ever be.
Lenders base their decisions largely on risk. Does this applicant have enough income or resources to pay off this loan? Does this applicant have a good record of paying off other loans or debts? Does this applicant have any other problems that could affect their ability to make payments?
Tax debts and liens are just such problems. They appear in your credit report, which is carefully screened by potential lenders. Since lenders also require recent tax returns in order to confirm your income and financial information, the presence of tax debts, liens and unfiled taxes will be evident there as well.
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.
Is a Mortgage Possible with Unfiled Taxes?
One of the first things a potential lender will require is copies of recent income tax forms. If you don’t have any – if you haven’t filed your taxes every year – that is obviously going to draw the lender’s attention. For one thing, the information needed from income tax returns is not available if there are no income tax returns.
Evaluating mortgage applications is largely about assessing and managing risks. If a person hasn’t filed taxes, that suggests the person is not a safe risk. There may be valid reasons for not filing taxes, but the lender will want to hear them before approving a mortgage application. There are steps you can take if you didn’t file your taxes.
Some lenders will approve a mortgage if you can demonstrate you have a structured repayment plan. The best approach is to consult with lending institutions before applying for a mortgage. Learn what you can do to improve your prospects before starting the process.
Owing Taxes and Selling Your Home
Remember: A tax lien discourages lenders because the IRS has first dibs on your property in case of default. Lenders thus lose their most significant collateral and leverage.
The same logic applies when you’re selling a home while owing back taxes. If there is a tax lien on the home, proceeds from a sale must first go toward settling the lien. Only then can the seller receive funds from the sale. If proceeds from the sale aren’t enough to cover the lien, you are still responsible for the remaining debt.
One alternative is approaching the IRS or state agency and trying to negotiate for a discharge of the lien. This can be done before or during the sale process and often requires the assistance of a tax attorney. Selling a home is complicated under the best circumstances. A tax debt adds an extra challenge.
Owing Taxes and Refinancing Your Home
Refinancing your home loan is much like acquiring the loan in the first place and tax debts and liens can become a factor. In both cases, it helps if you have already engaged in an approved payment plan and can show the lender that you have successfully met your obligations.
If there is a tax lien on the home, the lender may insist that the lien be paid off with the refinanced amount of the loan. That removes the IRS from the equation and ensures the lender the loan is fully secured by the property.
Another alternative is to apply for a subordination of the lien, which means the IRS allows creditors such as your lender to move ahead of the IRS’s claim on your property. It may require a tax attorney to negotiate a subordination or discharge of the lien.
Tips for Buying a House While Owing Taxes
In a perfect world, everyone would file their taxes and get a nice refund and never cross paths with IRS auditors.
This is not a perfect world.
Falling behind on filing or paying your taxes can and does happen to thousands of people. It is more useful to focus on resolving your tax debts and moving forward with a clean financial profile. There are things you can do to improve your situation and increase your chances of accomplishing life goals such as buying a home.
- Know where you stand: Denial is one of the main reasons people get into deeper trouble when it comes to taxes. One of the best ways to get out of trouble is to learn exactly how much you owe and the ways that debt is affecting your credit score. Once you take that first step, you can take appropriate action.
- Set up a payment plan: The IRS and state tax authorities are motivated to help recover as much tax revenue as possible. That makes working with individuals a lot more appealing than simply punishing them. Take the first step by contacting the IRS or state agency to address your debt with an approved payment plan. This will help you deal with the debt while also showing potential lenders that you are responsible when it comes to your financial obligation.
- Consult a tax professional: An experienced tax expert or tax attorney will know the latest strategies to deal with complex tax issues. They are trained to negotiate with the IRS and state agencies. Their mere presence shows officials that you are serious about addressing your debts.
- Be proactive: Protecting your financial health is similar to protecting your physical health. Learn to improve your credit score and avoid getting into debt you can’t manage. Stay current with payment obligations, whether it’s taxes, your mortgage or car loan or your credit cards. Saving money can help with a down payment or almost any debt issue that arises.
Homeownership and Taxes
Buying a home is one of the cornerstones of the American Dream as well as one of the most significant financial decisions of your life. But it’s just the start.
Owning a home is an ongoing series of problems, solutions, rewards, and challenges. Minimizing problems by using common sense is important, whether you’re talking about the plumbing or your taxes.
Don’t allow tax problems to grow unmanageable by failing to address them. Stay up to date, take whatever steps you can to deal with issues and seek professional advice when necessary. Tax professionals, including attorneys, can be vital resources when dealing with complex issues like taxes and financial obligations.
If you have a leak, you wouldn’t hesitate to call a plumber. Home ownership comes with new challenges, but even tax debts can be overcome. With the right approach and proper guidance, the joys of home ownership are within reach.
About The Author
After decades as a reporter and columnist for the Philadelphia Inquirer and ESPN, Phil Sheridan turned to writing about financial advice. He approaches the job with the curiosity of the stakeholder and the communication experience of a veteran journalist. He spent over 30 years learning about labor negotiations, salary caps, stadium negotiations and a lot of other finance-related matters. Better yet, he got to interview and chat with the real experts on these issues. Phil will use those contacts and experiences to make readers more comfortable about their financial situation.
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- Birk, C. (2013, May 29) How to Tackle a Tax Lien and Secure Your VA Home Loan. Retrieved from https://www.veteransunited.com/valoans/how-to-tackle-a-tax-lien-and-secure-your-va-home-loan/