If You Owe Taxes Can You Buy a House?

Many potential homebuyers worry that owing taxes might prevent them from purchasing a house. While tax debt does not automatically disqualify you from securing a mortgage, it introduces complexities. Understanding how lenders view tax obligations and how to manage such debt effectively is crucial. This article explores the impact of tax debt on credit and the specific considerations lenders make during a mortgage application.

Understanding Tax Debt and Home Buying Eligibility

When considering home buying, “owing taxes” refers to past-due income taxes or other significant, unsatisfied tax liabilities, distinct from current tax withholdings. Mortgage lenders assess an applicant’s overall financial health, and outstanding tax debt is part of this evaluation. Lenders ensure a borrower can comfortably manage new mortgage payments alongside existing financial commitments. Unpaid taxes, especially if substantial, can indicate financial instability. While not an absolute barrier, tax debt requires careful management and transparency with lenders. Demonstrating a proactive approach to resolving the debt is viewed favorably.

How Unpaid Taxes Impact Your Credit

Unpaid taxes can significantly affect your credit report and score, primarily when the IRS files a federal tax lien. A federal tax lien is a legal claim against a taxpayer’s property, including real estate, when tax debt is neglected. While federal tax liens no longer automatically appear on credit reports from the three major credit bureaus as of April 2018, they remain public records. Lenders, employers, and landlords can still access these records, influencing their decisions regarding creditworthiness. The public nature of a tax lien can make it more difficult to secure loans or other forms of credit. If a tax lien is not paid, it can remain a public record for an extended period, potentially beyond ten years, as long as the tax liability is outstanding. A public record of a tax lien can lead to higher interest rates on loans or even denial of credit, including mortgages.

Mortgage Lender Considerations for Tax Debt

Mortgage lenders employ specific criteria when evaluating applicants who have tax debt. A primary concern is the applicant’s debt-to-income (DTI) ratio, which measures the percentage of gross monthly income that goes toward paying debts. Any ongoing tax payment plans, such as an IRS Installment Agreement, contribute to this ratio, as the monthly payment for the tax debt is added to other monthly obligations. Lenders typically prefer a DTI ratio below 36%, though some programs may allow for higher percentages, potentially up to 43% or more depending on the loan type and other compensating factors. Lender policies regarding tax liens vary. Some lenders may require that any federal tax lien be fully satisfied and formally released before they will approve a mortgage. Other lenders, particularly those offering government-backed loans, may be more flexible, allowing an established payment plan with the IRS to be in good standing. For instance, Fannie Mae and Freddie Mac guidelines allow for borrowers with IRS installment agreements, provided the monthly payment is included in the DTI calculation. A tax lien that has been paid off and released is viewed differently than an active, unpaid lien. If a lien exists, some conventional loan programs may not be available. However, if a borrower has entered into an IRS Installment Agreement or an Offer in Compromise (OIC), lenders may accept this arrangement. An OIC is where the IRS agrees to accept less than what is owed. Lenders want assurance that the tax debt is actively managed and the borrower is not at risk of further collection actions.

Navigating the Mortgage Application Process with Tax Debt

When applying for a mortgage while carrying tax debt, honesty and full disclosure to the mortgage lender from the outset are paramount. Providing complete and accurate information about tax liabilities and any existing payment arrangements helps to build trust and streamline the application process. Attempting to conceal tax debt can lead to significant delays or outright denial of the loan.

Lenders will likely request specific documentation to verify the status of your tax debt and payment arrangements. If you have an IRS Installment Agreement, you will need to provide proof of this agreement, often evidenced by IRS Form 9465, “Installment Agreement Request.” This form outlines the terms of the monthly payment plan. Lenders will also want to see evidence that payments have been made consistently and on time, typically requiring at least three months of on-time payments, though some may require only one.

In cases where an Offer in Compromise (OIC) has been accepted by the IRS, documentation of the accepted OIC will be required. An OIC is a formal agreement where the IRS settles a tax liability for less than the full amount owed, based on the taxpayer’s ability to pay. If a federal tax lien was previously filed and has since been satisfied, lenders will require a Certificate of Release of Federal Tax Lien, which is IRS Form 668(Z). This document officially removes the government’s claim on your property. These documents enable the lender to verify that the tax debt is either resolved or being managed through an approved and current payment plan, thereby assessing the associated financial risk.