Can I Get a Mortgage If I Owe Back Taxes?

Owing back taxes is a common concern for prospective homebuyers, often raising questions about mortgage eligibility. While it might seem like a major obstacle, tax debt does not automatically disqualify an individual from securing a home loan. Mortgage approval with tax debt depends on the type and amount owed, the borrower’s financial health, and steps taken to address the debt.

How Lenders View Back Taxes

Mortgage lenders assess a borrower’s financial stability to determine their capacity to manage new debt obligations, like a mortgage. Unpaid tax debt signals potential financial instability or competing claims on a borrower’s income, making borrowers appear a higher risk. Lenders scrutinize financial history, including credit scores, income, and existing debts, to evaluate this risk.

One significant metric lenders evaluate is the debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. If back taxes necessitate a substantial monthly payment, this can increase a borrower’s DTI, potentially affecting their ability to qualify for a mortgage. Lenders generally prefer a DTI ratio below 43%, though some may accept slightly higher ratios.

While back taxes do not directly appear on credit reports or impact credit scores, their indirect effects can be damaging. For instance, if unpaid taxes lead to financial strain, it might result in missed payments on other credit accounts, which directly lowers a credit score. Lenders carefully review two years of tax returns as part of the mortgage application process to understand income stability and identify any undisclosed tax liabilities.

Impact of IRS Tax Liens

Unpaid tax debt can lead the Internal Revenue Service (IRS) to file a federal tax lien. This is a legal claim against a taxpayer’s property, including real estate, to secure the tax debt.

Lenders discover tax liens through various due diligence processes, including title searches and inquiries with state and county offices where the borrower lives, conducts business, or owns property. The IRS generally files a Notice of Federal Tax Lien (NFTL) with the county clerk’s office where the property is located. An NFTL on a property significantly impacts a borrower’s ability to secure a mortgage.

A federal tax lien typically has priority over other creditors’ claims, meaning the IRS is paid first if the property is sold. This superior claim makes lenders hesitant to issue a mortgage on a property encumbered by such a lien, as it reduces their security interest. While a mortgage lien generally has first priority for repayment, a federal tax lien can still complicate matters, and some tax liens, like those for unpaid property taxes, can even take precedence over existing mortgages.

Strategies for Addressing Back Taxes

Addressing outstanding tax debt proactively is a key step for individuals seeking a mortgage. The simplest solution for mortgage eligibility is to pay the back taxes in full. This eliminates the debt and improves a borrower’s chances of approval.

If full payment is not feasible, an Installment Agreement (IA) with the IRS offers a structured repayment plan, typically up to 72 months. Lenders view established IAs more favorably than unresolved tax debt, as it shows commitment. Lenders often require proof of an approved IRS installment agreement, including the monthly payment and total due, and evidence of consistent, on-time payments, sometimes for a minimum of three months. The monthly IA payment will be included in the borrower’s debt-to-income ratio.

An Offer in Compromise (OIC) allows taxpayers to settle their tax debt for a lower amount. An OIC is considered when a taxpayer cannot pay the full liability or doing so would create significant financial hardship. Qualifying for an OIC is stringent, requiring the taxpayer to have filed all necessary tax returns and be current on estimated payments. Lenders may view an OIC with more caution than an IA because the IRS does not release federal tax liens until OIC terms are fully satisfied.

A “Currently Not Collectible” (CNC) status is an option for taxpayers experiencing financial hardship, meaning the IRS has determined that they cannot pay their tax debt without compromising their ability to meet basic living expenses. While in CNC status, the IRS suspends collection activities, but interest and penalties accrue, and the IRS may still file a Notice of Federal Tax Lien. Although it offers temporary relief, individuals in CNC status typically have very limited disposable income, making mortgage qualification challenging.

Applying for a Mortgage with Tax Debt

Once a strategy for managing back taxes is implemented, the next step is the mortgage application. Transparency with lenders from the outset is important. Discuss your tax situation and resolution steps with potential mortgage lenders.

Lenders require specific documentation to verify the tax debt status and resolution plan. This includes the approved IRS installment agreement letter, detailing monthly payment and total amount due. Borrowers must also provide evidence of consistent, on-time payments towards the tax debt, often demonstrating several months of adherence. If a tax lien was filed, documentation of its release or subordination is necessary.

Different lenders have varying requirements regarding tax debt. Some lenders, including those offering FHA loans, may consider applications with an active IRS installment agreement. Others, such as Fannie Mae and Freddie Mac, generally do not approve mortgages if a Notice of Federal Tax Lien has been filed, unless it has been released. Some lenders might also require a certain number of on-time payments, such as three months, on an installment plan before considering a loan.