Can I Get a Mortgage if I Owe Taxes?

Obtaining a mortgage with outstanding tax debt is a common concern for prospective homeowners. While it might seem like an automatic disqualifier, it does not always prevent mortgage approval. Lenders assess a borrower’s financial standing, and tax obligations are a significant part of that evaluation. Securing a home loan with tax debt depends on the debt’s type and status, and the borrower’s efforts to address it.

How Lenders View Outstanding Tax Debt

Lenders view outstanding tax debt as an indicator of financial risk. They are concerned with a borrower’s ability to make mortgage payments and the possibility of tax authorities having a superior claim on the property. Unpaid taxes can suggest financial difficulty, which lenders consider when evaluating creditworthiness.

Lenders use the debt-to-income (DTI) ratio, comparing monthly debt payments to gross monthly income. If a borrower has an active payment plan for tax debt, these payments are included in the DTI calculation. For example, a $500 monthly IRS installment payment adds to your total monthly debt. Most lenders prefer a total DTI ratio, including housing and other debts, to be no higher than 36%, though some programs allow up to 43%.

The IRS does not directly report tax debt to credit bureaus, but severely delinquent accounts sent to collections can result in a derogatory mark. Tax liens, which are legal claims against property, are public records. Even though federal tax liens no longer appear on standard credit reports as of 2018, lenders can discover them through public record searches or by requesting tax transcripts. A tax lien signals a significant financial obligation, as it could grant the government a priority claim on assets, including the mortgaged property.

Specific Tax Debts and Their Mortgage Impact

Different categories of tax debt have distinct implications for mortgage eligibility. Federal or state income tax debt, from unpaid taxes or unfiled returns, often comes to light when lenders review two years of tax returns. While owing income taxes without a formal lien is challenging, a tax lien significantly compounds the issue. Lenders view these debts as a reflection of a borrower’s financial management.

Unpaid property taxes are a serious concern for mortgage lenders. These local government taxes on real estate are a senior lien, taking precedence over most other claims, including the mortgage. If property taxes remain unpaid, the taxing authority can sell the property at auction to recover the debt, potentially extinguishing the mortgage lender’s interest. This superior claim makes lenders sensitive to any delinquency in property tax payments, whether on a current home or the property being purchased.

For self-employed individuals, other tax debts like unpaid payroll or business taxes also influence mortgage qualification. Lenders scrutinize the financial health of a self-employed applicant’s business, often requiring business tax returns and profit and loss statements in addition to personal tax documents. Unresolved business tax liabilities can indicate financial instability, impacting the lender’s assessment of the borrower’s capacity to manage a mortgage. Any tax debt associated with the income reported for qualification must be fully satisfied or managed under an approved payment plan.

The most significant obstacle posed by tax debt is a tax lien. A tax lien is a legal claim placed by a governmental authority—federal, state, or local—against a taxpayer’s assets when a tax debt is neglected. For federal taxes, the IRS issues a Notice and Demand for Payment. If the debt remains unpaid, a Notice of Federal Tax Lien is filed publicly, asserting the government’s legal right to the taxpayer’s property. This lien attaches to all current and future property owned by the taxpayer, including real estate.

Tax liens are problematic because they grant the taxing authority a priority claim over many other creditors, including mortgage lenders, in a default or foreclosure. This means the government could seize and sell the property, potentially leaving the mortgage lender with little or no recovery. Most mortgage lenders will not approve a loan when an active tax lien is present. While tax liens no longer appear on consumer credit reports, their public record status allows lenders to discover them, making them a significant barrier to financing.

Resolving Tax Issues Before Mortgage Application

Addressing outstanding tax debt proactively can improve your mortgage application prospects. The simplest approach is to pay off the entire tax debt, including penalties and interest, before applying for a mortgage. This eliminates the debt as a concern for lenders and prevents new tax liens. If full payment is not feasible, several formal resolution options exist with tax authorities.

One common resolution is an installment agreement, allowing taxpayers to make monthly payments over time. The IRS offers these plans, typically for up to 72 months, for tax balances under $50,000. State tax agencies also provide similar payment arrangements. Lenders factor these monthly payments into your debt-to-income ratio, like other recurring debts.

Lenders view installment agreements favorably if you demonstrate consistent, on-time payments. For example, some conventional loan programs may require at least one on-time payment, while FHA loans often require a minimum of three months of successful payments. The formal agreement must be documented and readily available, as lenders verify the terms and payment history. If an existing tax lien is present, an FHA loan might still be possible if the IRS agrees to subordinate its claim, though conventional loans require the lien to be fully resolved.

Another option for federal tax debt is an Offer in Compromise (OIC), allowing certain taxpayers to settle their tax liability for a lower amount. The IRS determines OIC eligibility based on factors like ability to pay, income, expenses, and asset equity. The IRS Fresh Start program has expanded access to OICs, making it easier for some taxpayers to qualify. However, OICs are not always accepted, and lenders prefer the tax debt is fully resolved or the OIC is formally accepted and its terms met before approving a mortgage.

Regardless of the resolution method chosen, obtaining tax transcripts directly from the IRS is an important step. Lenders often require applicants to sign IRS Form 4506-T, which authorizes them to request transcripts to verify income, filing status, and payment history. This process helps lenders confirm the accuracy of financial information and the status of past tax issues. Consulting a qualified tax professional is also advisable to explore the most suitable resolution strategy and ensure compliance.

Navigating the Mortgage Application with Tax Debt

When applying for a mortgage with existing or past tax debt, full and honest disclosure to lenders is important. Attempting to conceal outstanding tax obligations can be viewed as loan fraud, leading to application denial and other severe consequences. Transparency allows the lender to assess your financial situation and guide you through the process, even if challenges arise.

Lenders require specific documentation to verify your tax status and any resolution efforts. This includes copies of your IRS-approved installment agreement, along with proof of consistent, on-time payments through bank statements or canceled checks. If a tax lien was previously filed, evidence of its release or subordination will be necessary. Lenders will also request you sign IRS Form 4506-T.

Different mortgage loan types have different requirements regarding tax debt. For FHA loans, an active federal tax lien may be permissible if a valid repayment agreement is in place and at least three months of on-time payments have been made. These payments cannot be prepaid. The monthly payment from the tax agreement will be included in your debt-to-income ratio. FHA loans have more flexible credit score requirements, accepting scores of 580 or higher for a lower down payment.

VA loans offer flexibility for service members and veterans with tax debt. While the VA does not set a minimum credit score, individual lenders require a FICO score of around 620. If a tax lien exists, a written payment agreement with the IRS is required. Some lenders look for 12 months of on-time payments, though others may accept fewer. The tax payment amount will be factored into the borrower’s debt-to-income ratio, which VA guidelines prefer to be below 41%, but exceptions are possible.

Conventional loans have stricter requirements. An active federal tax lien will disqualify an applicant, meaning the lien must be paid off or formally removed before approval. If only tax debt (without a lien) exists and an installment agreement is in place, conventional lenders may accept it, often requiring at least one on-time payment. These loans demand a minimum credit score of 620 and prefer a debt-to-income ratio below 45%. Regardless of the loan type, the lender’s underwriting department will scrutinize your tax debt and its resolution before a final decision.