Can You Get a Mortgage If You Owe Taxes?
Owe taxes but want a mortgage? Understand how tax debt impacts home loan eligibility and find actionable strategies for approval.
Tax debt can challenge mortgage applications, but it doesn’t automatically prevent homeownership. Lenders assess a borrower’s financial standing, and while tax debt adds complexity, options exist to resolve these obligations and secure a home loan. Mortgage eligibility often depends on the type and status of the tax debt, and the proactive steps taken to resolve it. Understanding its impact and resolution strategies is important for prospective homebuyers.
How Tax Debt Impacts Mortgage Eligibility
Outstanding tax debt directly influences a mortgage application. A federal tax lien, filed by the Internal Revenue Service (IRS), becomes public record and can significantly lower credit scores. Even without a lien, debt reported in collections affects creditworthiness. Lenders review credit reports and public records, viewing a tax lien as a failure to meet financial obligations.
Payment plans for tax debt, like an IRS Installment Agreement, factor into an applicant’s debt-to-income (DTI) ratio. A higher DTI, which compares monthly debt payments to gross monthly income, can limit borrowing capacity or affect loan approval. Lenders see outstanding tax debt as an increased financial risk, suggesting potential instability or a higher likelihood of defaulting on new mortgage payments.
Beyond federal income tax, other tax obligations can also impact eligibility. Delinquent state income tax, local property tax, or unpaid payroll taxes can create similar hurdles. These debts may lead to liens or collection actions by taxing authorities, which lenders consider during underwriting. The impact often depends on the amount owed and delinquency duration.
Strategies for Addressing Tax Debt for Mortgage Qualification
Paying tax debt in full is the most effective solution for mortgage qualification, as it eliminates the liability and allows for quicker lien release. Once the debt is satisfied, obtain a Certificate of Release of Federal Tax Lien (CRFTL) from the IRS.
If full payment isn’t feasible, an Installment Agreement (IA) with the IRS is a common strategy. An IA is a formal plan allowing monthly payments, typically up to 72 months, for tax liabilities under $50,000. Establishing an IA demonstrates commitment, and lenders often require documentation like the IRS acceptance letter and proof of consistent payments.
An Offer in Compromise (OIC) allows taxpayers to settle debt for a lower amount under specific hardship circumstances. While an OIC can resolve tax debt, it involves a lengthy process, and its acceptance doesn’t guarantee immediate mortgage approval. Lenders may view an OIC differently than a fully paid debt or an established IA, requiring proof of an accepted OIC.
If a federal tax lien was filed, a CRFTL is necessary once the debt is paid. In specific situations, such as when an Installment Agreement is established through direct debit, a Notice of Federal Tax Lien may be withdrawn, removing it from public record. Providing all official IRS documentation, including payment confirmations, agreement letters, and lien releases, is important as lenders will require this proof to verify the status and resolution of the tax debt.
Mortgage Programs and Tax Debt Requirements
Different mortgage programs have specific requirements regarding tax debt that has been addressed or is under a repayment plan. Conventional loans, backed by Fannie Mae and Freddie Mac, typically have stricter guidelines. Lenders often prefer tax debt to be fully paid off and any associated liens released. If a repayment plan is in place, Fannie Mae may require a history of at least three months of on-time payments, and the monthly payment will be included in the borrower’s debt-to-income ratio calculation.
Federal Housing Administration (FHA) loans offer more flexibility for borrowers with IRS tax debt. FHA guidelines generally allow borrowers to qualify if they have an IRS Installment Agreement in place and have made at least three consecutive, timely payments. These must be actual monthly payments, not prepaid. For tax liens, FHA may permit them to remain unpaid if a valid repayment agreement exists and the lien holder subordinates the tax lien to the FHA-insured mortgage.
VA loans, designed for eligible service members and veterans, also provide options for those with tax debt. Similar to FHA, the Department of Veterans Affairs (VA) often allows borrowers with an established IRS Installment Agreement. Some VA lenders may require a longer history of on-time payments, such as 12 months. Regarding tax liens, VA generally requires them to be paid off or included in an approved payment plan, with subordination sometimes necessary to ensure the VA loan takes priority.
Beyond these common programs, some portfolio lenders or private mortgage lenders may offer more flexible criteria based on their internal risk assessments. Regardless of the loan type, lenders will require specific documentation. This includes copies of the IRS Installment Agreement, proof of payments made on the agreement, and any official notices of tax lien release or withdrawal. Providing these documents clearly and promptly streamlines the underwriting process.