Can I Get a Conventional Mortgage If I Owe Back Taxes?

A conventional mortgage is a home loan not insured or guaranteed by a government agency, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). These loans are typically offered by private lenders, including banks, credit unions, and mortgage companies, and are often backed by government-sponsored enterprises like Fannie Mae and Freddie Mac. While conventional loans often have stricter qualifying criteria compared to government-backed options, they remain the most common type of mortgage. Many potential homebuyers face the common concern of owing back taxes, which can complicate the mortgage application process. Despite the challenges, obtaining a conventional mortgage even with outstanding tax debt is frequently possible under specific conditions.

How Tax Debt Affects Mortgage Eligibility

Unpaid tax debt can significantly influence a borrower’s ability to qualify for a conventional mortgage. Lenders thoroughly evaluate an applicant’s financial standing, including any outstanding debts, to ensure they can meet monthly payments. Tax debt increases a borrower’s overall debt load, directly affecting their debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. Conventional loans generally prefer a DTI ratio below 45% to 50%, though this can vary. If tax debt pushes this ratio too high, it can make meeting lender qualifications more difficult.

While unpaid federal taxes themselves do not directly appear on credit reports, the IRS can file a Notice of Federal Tax Lien against property when taxes are neglected. Federal tax liens remain public records that lenders can discover during a thorough search. The presence of such a lien signals to lenders that the government has a claim on a borrower’s assets, indicating a history of financial irresponsibility or hardship. This can make lenders view the borrower as a higher risk, potentially impacting mortgage approval or leading to less favorable interest rates. Furthermore, if owing back taxes leads to missed payments on other financial obligations, such as credit cards or existing loans, this can indirectly and negatively impact credit scores.

Options for Addressing Back Taxes

Resolving outstanding tax debt with the IRS is a necessary step toward improving mortgage eligibility. The simplest and most direct solution is to pay the tax debt in full. This immediately eliminates the debt and removes any associated liens, which the IRS typically releases within 30 days of full payment.

If full payment is not feasible, an IRS Installment Agreement (IA) offers a structured monthly payment plan. Taxpayers can request an IA by filing Form 9465, which allows them to pay their tax liability over time, often up to 72 months. Once the IRS approves the request, Form 433-D, Installment Agreement, formalizes the payment plan, often requiring direct debit payments from a bank account. The total amount of tax, penalties, and interest owed for a streamlined installment agreement is typically capped at $50,000 for individuals.

A user fee applies to set up an IA, ranging from $31 for online direct debit agreements to $225 for agreements set up by mail or phone. Low-income taxpayers may qualify for a reduced fee of $43, or even a waiver or reimbursement if they cannot use direct debit. To maintain the agreement, taxpayers must make all payments on time and remain current with all future tax filings and payments.

An Offer in Compromise (OIC) allows certain taxpayers to settle their tax debt for a lower amount than what they owe, particularly when they face significant financial hardship. To apply, individuals typically submit Form 656, along with detailed financial information on Form 433-A or Form 433-B. The IRS evaluates an OIC based on the taxpayer’s ability to pay, considering income, expenses, and asset equity, to determine a “reasonable collection potential.” A non-refundable application fee, generally $205, and an initial payment are usually required with the OIC application, though low-income taxpayers may be exempt from the fee. The OIC process is more complex and lengthy than an IA, and the IRS will only approve an OIC if it is in the government’s best interest.

Lender Considerations for Tax Debt

Mortgage lenders have specific requirements when evaluating applicants with past tax debt. Lenders generally require proof that any outstanding tax debt is either fully paid or formally resolved through an IRS-approved payment plan. For an Installment Agreement, lenders typically want to see an approved agreement from the IRS and evidence that the borrower is current on payments. While Fannie Mae may require only one payment to have been made prior to closing, Freddie Mac generally looks for at least three months of on-time payments. The monthly payment amount for the Installment Agreement will be factored into the borrower’s debt-to-income (DTI) ratio.

The presence of a federal tax lien introduces additional considerations. Lenders generally require all past-due federal or state taxes, including tax liens, to be paid in full before closing. Freddie Mac requires the tax lien to be paid off or to be under a repayment plan for at least three months, with the payment included in the DTI calculation. In cases where a lien exists, lenders will often require the IRS to formally subordinate their lien, meaning the mortgage takes priority over the tax debt in the event of foreclosure. This ensures the lender’s interest is protected.

An Offer in Compromise (OIC) may be viewed differently by lenders due to its nature as a settlement for less than the full amount owed. While an accepted OIC resolves the debt, lenders might still assess the underlying financial circumstances that led to the OIC. It is generally more straightforward for lenders when the tax debt is fully paid or managed under a consistent Installment Agreement. Lenders prioritize a clear repayment history and a demonstrated ability to manage financial obligations.

Preparing Your Mortgage Application

Once tax debt issues are addressed, preparing a comprehensive mortgage application is crucial. Gathering specific documentation is paramount to show the resolution of tax debt. This includes the IRS Installment Agreement acceptance letter, such as Form 433-D, and proof of consistent, on-time payments. Acceptable evidence can include bank statements showing deductions or IRS payment transcripts.

If a federal tax lien was filed, providing the IRS tax lien release or subordination documents is essential to demonstrate that the claim on your property has been removed or prioritized behind the mortgage. For those who paid their tax debt in full, canceled checks, bank statements, or IRS account transcripts serve as proof of payment. If an Offer in Compromise was accepted, the acceptance letter and evidence of compliance with its terms will be necessary.

Proactive and transparent communication with potential lenders is highly advisable. Disclosing the tax debt situation upfront, along with a clear explanation of how it has been resolved, can build trust and streamline the application process. Seeking out lenders or mortgage brokers who have experience with applicants who have managed tax debt can also be beneficial, as they may be more familiar with the necessary documentation and specific guidelines. Once all documentation is prepared, the mortgage application process will typically proceed through stages such as pre-approval, full application, and underwriting, with the provided tax debt resolution evidence playing a significant role in the final approval.