Can You Get a Home Loan if You Owe the IRS?

Obtaining a home loan can seem challenging when you have outstanding tax debt with the Internal Revenue Service (IRS). Many individuals worry that owing the IRS will automatically disqualify them from securing a mortgage. While it adds a layer of complexity to the application process, it is often possible to get a home loan even with tax debt. The key lies in understanding how lenders view this debt and taking appropriate steps to manage it.

How IRS Debt Affects Home Loan Eligibility

Mortgage lenders view IRS debt as a serious financial obligation, similar to other forms of debt like credit cards or car loans. Their primary concern is a borrower’s overall financial stability and ability to manage all debts, including taxes, alongside a new mortgage payment. Unresolved tax debt can signal a higher risk to lenders.

A significant factor lenders consider is the borrower’s debt-to-income (DTI) ratio. This ratio compares your total monthly debt payments to your gross monthly income. Any formal payment arrangement with the IRS, such as an installment agreement, will have its monthly payment factored into your DTI ratio. A high DTI can make it more difficult to qualify for a mortgage, as lenders prefer a ratio around 43% or lower.

While simply owing the IRS does not automatically disqualify a borrower, the nature and management of the debt are important. Lenders scrutinize financial history, including credit scores and outstanding debts. An unmanaged tax liability or a recorded federal tax lien can hinder or prevent loan approval, as it indicates an unresolved financial obligation that could jeopardize the lender’s interest.

Specific Debt Situations and Lender Views

The manner in which IRS debt is being handled influences a lender’s decision. Different debt statuses present varying levels of challenge and require specific approaches to secure a home loan. Lenders assess each situation based on the level of risk and the clarity of the repayment plan.

Installment Agreement

When a borrower has established an Installment Agreement with the IRS, lenders are more willing to consider a loan application. This is a formal payment plan allowing taxpayers to make monthly payments for up to 72 months. Lenders often require proof of an approved agreement and a history of consistent, on-time payments. The monthly payment from this agreement will be included in the borrower’s debt-to-income ratio.

Federal Tax Lien

A Federal Tax Lien is a legal claim the IRS places against a taxpayer’s property when tax debt is unpaid. This public record makes it difficult to obtain a mortgage because the lien gives the IRS priority over other creditors in the event of a property sale or foreclosure. To proceed with a home loan, the tax lien must be satisfied by paying off the debt in full, or the IRS may agree to subordinate the lien. Subordination means the IRS temporarily moves its claim to a lower priority, allowing the new mortgage lender’s claim to take precedence. This process requires filing IRS Form 14134, “Application for Certificate of Subordination of Federal Tax Lien,” and demonstrates to the lender that their investment is protected.

Offer in Compromise (OIC)

An Offer in Compromise (OIC) is an agreement with the IRS to settle a tax debt for a lower amount than what is owed, typically considered when a taxpayer cannot pay the full liability. While an OIC can resolve tax burdens, its impact on mortgage eligibility depends on its status. If an OIC is pending or has just been accepted, lenders may be hesitant due to the ongoing negotiation or payment terms. Lenders prefer the OIC process to be completed or a sufficient number of payments made under an accepted OIC, and all required tax filings must be current.

Unresolved or Unpaid Taxes

The challenging situation for obtaining a home loan is having unresolved or unpaid taxes without a formal agreement in place. This indicates an unmanaged liability, which lenders view as a significant risk. In such cases, lenders require the borrower to resolve the debt, typically by establishing an Installment Agreement, before they will consider approving a mortgage. Without a clear plan for repayment, the tax debt remains an obstacle to loan approval.

Steps to Take When Applying for a Loan

Navigating the mortgage application process with IRS debt requires proactive preparation. Taking specific steps can improve your chances of securing a home loan. Transparency and diligent documentation are important when engaging with potential lenders.

Address the Debt

Begin by addressing the tax debt. Contact the IRS to understand the exact amount owed and to establish a formal payment arrangement, such as an Installment Agreement, if one is not already in place. This formal agreement is preferred by lenders over informal payment arrangements, as it demonstrates a structured approach to managing the liability. The IRS offers various payment options.

Obtain Documentation

Next, obtain documentation from the IRS regarding your tax debt and any payment arrangements. This includes a copy of the approved Installment Agreement, a detailed payment history showing on-time payments, or a certificate of lien release or subordination if applicable. Lenders will require this proof to verify the status of your debt and confirm your adherence to repayment terms.

Review Credit Report

It is advisable to review your credit report. While federal tax liens no longer appear on credit reports, they are public records and can still be discovered by lenders during the underwriting process. Ensuring the accuracy of all reported financial information, including any indications of past tax issues, is important.

Be Transparent

Transparency with potential lenders is important. Be upfront about your IRS debt from the beginning of the application process. Open communication helps build trust and allows the lender to guide you through the specific requirements for your situation.

Improve Financial Health

Finally, focus on improving your financial health. Reducing other outstanding debts, maintaining a strong payment history on all accounts, and building up savings can help offset the risk associated with tax debt. A lower debt burden and a healthier financial profile can strengthen your mortgage application.