You are ready to move into a new home to start a new chapter in your life. Qualifying for financing in order to purchase that home can feel like a daunting process, especially if you encounter murky waters with the IRS.
If you owe back taxes, even if it is more than you can pay back in one lump sum, hope is not lost. So, can you get a mortgage if you owe back taxes to the IRS? The good news is that you still can!
However, there are some stipulations and guidelines that you should be aware of in order to safeguard your eligibility with a lender.
Types of Back Tax Debt That Could Affect Your Mortgage Application
First, it’s important to note the difference between IRS (federal) back tax debt and state back tax debt. Aside from the jurisdiction of your debtor, the IRS and state officials also have different mechanisms for collecting taxes owed that can affect your mortgage.
Federal Tax Debt
The IRS, which takes care of federal taxes, has a system for due process that governs its handling of outstanding taxes. Specifically, the IRS is restricted from seizing assets until due process has been afforded. This makes it easier to work with them if you owe taxes and less risky from the perspective of a potential lender. For more information on IRS back taxes visit our back taxes help resources page or view our tax resolution services.
State Tax Debt
With a few exceptions, most state tax authorities do not have the same due process restrictions. This gives them much greater authority to seize assets.
The other issue is that there are differing levels of local tax authorities depending on where you live or plan to buy. State, county, and city officials all are governed by different rules, which can make obtaining a mortgage somewhat challenging.
How Back Taxes Factor in Debt-to-Income Calculations
Debt-to-income formulas are calculations that mortgage companies use to determine whether your income and savings are sufficient to cover your existing debt, as well as the debt you will incur from a new home loan.
These calculations are one of the main determinants for issuing a mortgage, which is why mortgage companies discourage applicants from making any large purchases or establishing new lines of credit once the application has been submitted. These things can skew the debt-to-income calculations, which can cause a company to back out of issuing a loan, even if you were pre-approved.
Back taxes, as a debt, will be weighed along with your other liabilities and debts against your income and savings. If your back taxes are significantly outweighed by your assets, then this will not hurt you during the process.
However, if your back taxes add an additional significant debt on top of other debts or liabilities, your debt-to-income ratio may not be strong enough for a mortgage company to risk taking a chance on you by issuing a loan.
Do You Have an IRS or State Lien on Your Current Property?
Failure or refusal to pay the taxes you owe can lead to the IRS placing you on a tax lien. This alert is then sent out to creditors, which can be viewed by potential lenders. A tax lien gives the government a claim to your personal property and taxes until your lien is resolved.
The difference in the type of lien you have on your property is entirely dependent on where you owe your taxes. For federal taxes, the lien will be issued from the IRS. For unpaid state taxes, your state tax agency will be the issuing agency. In some jurisdictions, this may also be done by local or county-level agencies.
If you are unsure whether or not your account is subject to a federal tax lien, you can call the IRS’s Centralized Lien Unit or their Office of Appeals.
How Does a Tax Lien Affect Buying a House?
Tax liens usually raise your risk profile for most mortgage actuaries. Frankly, the best solution is to pay off any liens before buying a new property.
Working with your debtor to establish a payment plan and schedule can also help in reassuring potential lenders. This demonstrates that there is a manageable plan and end date to the debt that can offset the uncertainty that makes mortgage companies hesitant to do business with you.
Whether your lien is imposed by the IRS or a state agency, the most important first step you can take is to be upfront with your mortgage company about your situation. Many mortgage companies have documentation and procedural requirements for handling situations like this. The earlier you broach this subject with them, the earlier you can complete the required steps.
Can You Get an FHA Loan if you Owe Back Taxes?
FHA loans are also made more complicated when you owe back taxes. FHA loans are contingent upon factors like income and credit history, even before considering tax issues.
Along with providing documentation for these requirements, you’ll also need to go through a manual underwriting process. This process will verify that you have created a repayment agreement with the IRS. Underwriters will also confirm that you have made at least your last three back tax payments on time.
Additionally, your overall tax debt also affects your ability to qualify for an FHA loan. Lenders will often include your scheduled tax payments when calculating disposable income and savings. Greater tax burdens lessen your disposable income, which can negatively skew your debt-to-income ratio (more on that later).
Can Military Borrowers with a Tax Lien Get a Home Loan?
As part of the benefits of military service, military borrowers with a tax lien do have an additional lending option from the VA.
While the VA offers an alternative to more risk-averse private lending companies, military borrowers will still need to complete essentially the same verification steps as FHA applicants.
You will need to show proof of an agreed-upon repayment plan, verify on-time payments for the last several months, and have an adequate debt-to-income ratio to justify the loan amount for the lender.
Can you Get a Reverse Mortgage if you Owe Back Taxes?
The issue with reverse mortgages and back tax debt is that reverse mortgages are entirely reliant on your current home equity. If the IRS or state officials have placed a lien on your property for tax non-payment, your equity is significantly diminished.
This makes it much harder to qualify for a reverse mortgage. However, some companies offer the same route for reverse mortgage applicants with back tax debt.
You need to show proof of your repayment plan, evidence of timely recent payments, and adequate income or investments to justify the loan risk for the company.
FAQ
Questions about getting a mortgage with back tax debt? We have the answers.
Yes. Underwriters examine your entire financial history for any potential liabilities. Because tax records are part of your reported credit history, they will see any outstanding tax issues or liabilities.
Yes. To prevent fraudulent tax reporting, mortgage companies will always verify your tax returns with the IRS.
If not right away, then eventually. Since the seller will be asked to pay capital gains taxes on their proceeds of the sale, they must report the sale – and usually as soon as it is completed. This means even if you don’t report it, someone will.
Yes. One of the main questions a lender asks of buyers is to report any outstanding tax or debt issues as part of the approval process. Even if you don’t report them, the underwriting process is designed specifically to discover these types of issues to mitigate risk from any issued loan.
