Can You Buy a House If You Owe Taxes?

Individuals often consider purchasing a home while managing outstanding tax obligations. Tax debt can influence various aspects of a home purchase, particularly mortgage eligibility. Understanding how these financial commitments interact is important for navigating the housing market effectively.

Impact of Tax Debt on Mortgage Eligibility

Owed taxes can significantly impact an individual’s ability to qualify for a mortgage, primarily from a lender’s perspective. Lenders thoroughly assess a borrower’s financial health to determine their creditworthiness and the risk associated with extending a loan. The presence of outstanding tax debt directly factors into this evaluation.

A borrower’s credit score is one affected area. While federal tax liabilities don’t appear on credit reports, severe delinquencies leading to collection actions, like a federal tax lien, can significantly drop scores. Lenders review credit reports and often discover tax liens through public record searches during underwriting. A lower score signals increased risk, potentially leading to denial or less favorable loan terms.

Lenders also scrutinize a borrower’s debt-to-income (DTI) ratio, comparing monthly debt payments to gross monthly income. Payments for outstanding tax debt, including those under an installment agreement, are included. If tax debt payments elevate the DTI ratio beyond a lender’s acceptable threshold, it can hinder mortgage approval. All types of tax debt are viewed as financial obligations affecting a borrower’s capacity to manage new mortgage payments.

Lenders employ various methods to uncover outstanding debts, including tax obligations. They often require applicants to submit tax returns for the past two years, which can reveal federal tax debt. Additionally, lenders conduct public record searches to identify any tax liens filed against a property or individual. Being transparent with lenders about any existing tax debt and payment plans can be beneficial, as hiding such information could be considered loan fraud.

Federal Tax Liens and Home Buying

A federal tax lien is the government’s legal claim against a taxpayer’s property for unpaid tax debt. This claim secures the government’s interest in all assets, including real estate, personal property, and financial assets. A federal tax lien arises after the IRS assesses a tax liability, sends a “Notice and Demand for Payment,” and the taxpayer fails to pay.

The IRS files a public document called a Notice of Federal Tax Lien (NFTL) to formally alert other creditors that the government has a legal right to the taxpayer’s property. This notice is filed in the public record of local recording offices, making it discoverable during public records searches performed by lenders. While a federal tax lien does not appear on credit reports directly, its public nature means lenders will find it during their due diligence.

The presence of an NFTL poses a significant challenge to obtaining a mortgage because it establishes the government as a senior creditor. This means that in the event of a property sale or foreclosure, the government’s claim on the property’s proceeds generally takes precedence over other lenders’ claims. Most lenders are unwilling to approve a mortgage when an active federal tax lien exists, as it compromises their ability to recover their investment if the borrower defaults.

It is important to distinguish between a tax lien and a tax levy. A tax lien secures the government’s interest in property, while a tax levy is the actual seizure of property to satisfy a tax debt. The IRS files a lien to secure payment before resorting to a levy. Only the lien impacts a property’s title and marketability for a home purchase.

Resolving Tax Debt to Facilitate Home Purchase

Addressing outstanding tax debt is a proactive step to improve one’s ability to purchase a home. Direct communication with tax authorities, such as the IRS, is a necessary first step to explore resolution options. Ignoring tax debt can lead to more severe collection actions that further complicate financial standing.

One solution is full payment of the tax debt, including any penalties and interest. If feasible, this removes the tax obligation and eliminates financial obstacles to a mortgage. Lenders prefer a clear resolution of tax debt before approving a loan.

When full payment is not possible, an Installment Agreement (IA) offers a structured payment plan with monthly payments. IRS Form 433-D is used to finalize these agreements, especially for direct debit payments. Establishing an IA and maintaining current payments can make tax debt manageable for lenders, demonstrating a commitment to resolving the obligation.

An Offer in Compromise (OIC) allows certain taxpayers to settle their tax debt for a lower amount than what is owed. This option is considered when a taxpayer faces significant financial hardship and cannot pay the full liability. The process involves submitting Form 656, along with financial statements like Form 433-A or Form 433-B. While an OIC can provide substantial relief, it is a complex process with specific eligibility requirements and no guarantee of acceptance.

In situations involving a federal tax lien, the IRS offers specific actions to facilitate a home purchase or refinancing. A subordination of a federal tax lien, requested using Form 14134, allows a new lender’s claim to take priority over the existing IRS lien without removing the lien itself. This enables a borrower to secure a mortgage, as the lender’s interest is protected. A withdrawal of a federal tax lien, requested through Form 12277, removes the public Notice of Federal Tax Lien, though the tax liability remains. This can help improve credit standing and clear public records.