When you’re planning to buy a house, various financial factors come into play, and one key consideration is whether you owe taxes. The simple answer is: “maybe.” The situation can be very complex, and working with a tax professional is always the safest route. Let’s consider your options and various important issues that come into play if you’re trying to buy a house and have tax debt.
Identifying the Issue: Tax Lien or Tax Debt?
A tax debt refers to the amount you owe the IRS after filing your income taxes. This can happen when you’re unable to pay your tax bill in full or when you have unfiled taxes for a particular year. Tax debt doesn’t necessarily prevent you from buying a house, but it can make the process more challenging.
On the other hand, a federal tax lien is a claim made by the government against your property when you neglect or fail to pay a tax debt. An IRS tax lien is not just limited to federal tax debt; if you owe state taxes, the state can also impose a tax lien on your property. This tax lien can greatly impact your ability to buy a house, and dealing with it should be a priority if you’re planning on becoming a homeowner.
How Tax Debt Affects Mortgage Approval
Mortgage lenders take on a considerable amount of risk when they approve a home loan, and they evaluate an applicant’s financial profile carefully to ensure they can meet the monthly payments. When you apply to get a mortgage, the lender will examine your financial standing, including any outstanding debts, tax debt, and, of course, any federal tax lien. They will also look to see if you owe tax debt to a state as well as at your IRS tax bill.
Lenders often consider tax debt as a negative mark on your creditworthiness, mainly because it indicates a history of financial irresponsibility or hardship. This can affect your debt to income ratio, a key factor in the loan approval process. This ratio compares your monthly debt payments to your gross monthly income. If you owe a substantial amount of tax debt, your debt to income ratio might exceed what most lenders are comfortable with, complicating your mortgage approval process.
The type of mortgage also matters. For instance, if you’re applying for a conventional loan, you might face stricter requirements. Conventional loans are usually issued by private lenders, and they often have stricter credit score and debt-to-income ratio requirements than government-backed loans, such as FHA loans or VA loans.
How Does a Federal Tax Lien Affect Buying a House?
A tax lien can cause a significant drop in your credit scores, making it harder for you to secure favorable mortgage loans. Additionally, if a tax lien is filed against you, it’s public information and will appear on your credit reports, making it known to potential lenders that you have unpaid taxes.
Having a tax lien can hamper your home buying process in multiple ways. Not only does it damage your credit, but it also attaches to all your property, including any new property you acquire while the lien is in place. This means that if you do manage to buy a house while a tax lien is still in effect, the house will automatically have the lien attached to it.
Most lenders will not approve a mortgage application while there’s an active tax lien. The presence of a lien indicates to mortgage lenders that their claim on the property may not be first in line, as the government’s claim would come first in the event of a sale.
Other Ways a Tax Lien Affects Buying a House
Besides affecting your ability to secure a mortgage, a tax lien can also affect other facets of the home buying process. For instance, a tax lien can cause difficulty in securing home insurance—a requirement for most mortgages. Also, you may face challenges when trying to sell the home later, as any proceeds from the sale might be used to pay off the tax lien first.
Furthermore, a tax lien can limit your options when seeking other forms of credit necessary for homeownership, such as home improvement loans or lines of credit. With a tax lien affecting your credit score, obtaining these could be challenging.
Even after the lien is resolved, its impact can still linger. Credit bureaus may keep tax liens on credit reports for seven years from the date of payment, affecting your ability to secure favorable interest rates long after the tax issues are resolved.
Can You Get a Mortgage if You Have IRS Tax Debt?
Federal tax debt is a serious issue that can hinder your ability to get a mortgage, but it’s not necessarily an insurmountable obstacle. Lenders require applicants to be financially responsible and capable of making their mortgage payments. Therefore, having unpaid taxes can cast doubt on your financial stability and make it harder to buy a house: but not necessarily impossible.
The key lies in how you handle your tax debt. If you agree to a payment plan with the IRS, make your monthly payments consistently, and prove that you can manage the debt while affording a house, you may be able to convince lenders to approve your loan. You may need to go through a manual underwriting process, where the lender takes a closer look at your financial situation to make an informed decision.
When entering into a repayment agreement, make sure the additional monthly payment won’t negatively impact your debt-to-income ratio or your ability to make your mortgage payments. Also, it’s important to note that some mortgage programs, like FHA loans and VA loans, have specific rules about delinquent tax debt and may require you to have a repayment plan in place before approving your loan application.
How Do Lenders Know You Owe Taxes?
Mortgage lenders typically require applicants to submit tax returns for the past two years as part of the home loan application process. This can reveal if there’s federal tax debt.
Moreover, unpaid taxes will show up on your credit reports. Mortgage lenders check these reports thoroughly before deciding to approve or reject your application.
Even if you have tax debt, it’s crucial not to hide this information from your potential lenders. Being upfront about your situation can provide an opportunity for you to discuss your payment plan and demonstrate your commitment to handling the debt responsibly.
So, while owing taxes can make the home buying process more complex, it’s not necessarily a deal-breaker. The critical factor is how you manage your tax liabilities.
If you’re in this situation, talk with a tax professional: an experienced tax attorney. They can provide advice tailored to your unique circumstances, helping you navigate the process and work towards your goal of homeownership.
Is It Possible to Get an FHA Loan With Back Taxes Owed?
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development, provides mortgage insurance on loans made by FHA-approved lenders.
These loans are popular with first-time homebuyers due to their low down payment requirements and more lenient credit score standards. But what happens if you owe back taxes?
The FHA has clear guidelines for applicants with delinquent federal tax debt. To be eligible for an FHA loan, you must either:
- Have entered into a valid repayment agreement with the Internal Revenue Service and made at least three months’ worth of timely payments
- Have received permission from the IRS to delay payment on the tax debt.
The lender will need to verify this information during the underwriting process. Having unpaid taxes doesn’t automatically disqualify you from an FHA loan, but it does necessitate an approved payment plan.
Can You Get a Conventional Loan With a Tax Lien?
Conventional loans are mortgages not guaranteed by the federal government. They are often considered more challenging to qualify for because they generally require higher credit scores and larger down payments.
While it’s possible to secure a conventional loan with a tax lien, it’s generally more difficult. Most lenders see a tax lien as a significant risk because it shows you’ve defaulted on a federal debt.
Additionally, in the case of foreclosure, the government’s lien will take precedence over the lender’s claim to the property.
However, just like with FHA loans, having a payment plan in place can make a significant difference. If you’re current on your payment plan and can demonstrate that you can handle both the plan payments and your potential mortgage payments, some lenders may consider your application. If you already own property sufficient to pay off your tax debt in the event you cannot make the payments, and if you have no other major debts, this may also be taken into consideration.
Can You Buy a House If You Owe State Taxes?
Just like owing federal taxes, state tax debt can also impact your ability to buy a house. State tax liens, like federal tax liens, can be attached to your property, making it difficult to secure a mortgage loan.
State tax debt is usually revealed during the mortgage application process when you submit your tax returns or during a credit check.
Once again, the key lies in having a structured payment plan with the state tax authority. Demonstrating that you’re actively handling your state tax liability can increase your chances of securing a mortgage loan.
How Federal Tax Liens Affect Selling Your Home
A federal tax lien on a home can make selling the property more complex because the lien often needs to be paid before transferring ownership.
Upon the sale of your home, the proceeds will typically go towards settling the tax lien first before you receive any funds. However, if the proceeds from the sale are not enough to cover the lien, you’ll still be responsible for the remaining tax debt.
In some cases, the IRS might agree to discharge a tax lien to allow the sale to proceed, but this often requires substantial negotiation and the assistance of a tax professional.
Decide on a Plan
When facing tax debt and seeking to buy a house, it’s essential to have a comprehensive plan. Your plan should not only consider your current financial situation but also your future financial responsibilities, including potential mortgage payments and any current repayment agreement with the Internal Revenue Service or state tax authority.
This plan should be built in consultation with a qualified tax lawyer. Purchasing a house is a significant financial commitment, and your plan should account for the additional monthly payments, as well as other homeowner expenses like property taxes, home insurance, and maintenance.
Before proceeding with a home purchase, you should also consider the impact of a mortgage on your debt-to-income ratio.
Set up a Payment Plan with the IRS
If you have tax debts, agreeing to a payment plan with the IRS can significantly improve your chances of obtaining a mortgage. An installment agreement allows you to make manageable monthly payments towards your tax liability, demonstrating to lenders that you’re actively addressing your tax issues.
There are several types of payment plans, including short-term payment plans and long-term payment plans (also known as installment agreements). Depending on the amount of tax debt and your financial situation, you may be eligible for one of these plans.
How Tax Debt Affects Refinancing a Home Loan
If you owe taxes and are looking to refinance your home, you may encounter some hurdles. Similar to the initial mortgage approval process, most lenders will consider your current tax situation during refinancing.
A lien can pose significant issues as it signifies a higher risk level to lenders. As with buying a house, having an approved and active payment plan can increase your chances of getting approved for a refinance.
Selling or Refinancing When There Is a Lien From the IRS
Selling or refinancing a home when there’s an IRS lien can be complicated. The proceeds from selling the house will normally be used to pay off the lien first before you see any profit. In the case of refinancing, the lender may insist the lien be paid off with the refinanced amount to ensure their loan is fully secured by the property.
In some cases, you may apply for a “discharge” of the lien to sell your home. This is a process in which the IRS removes the lien from the property to allow the sale to proceed. Alternatively, for refinancing, you can apply for “subordination,” where the IRS allows other creditors (like your refinancing lender) to move ahead of the IRS claim on your property.
Both options require significant negotiations with the IRS and the assistance of a tax professional like an experienced tax attorney.
Tips for Buying a House With Back Taxes Owed
If you owe back taxes and are considering buying a house, here are some tips to increase your chances of success:
Understand Your Tax Liabilities
Know how much you owe and how it’s affecting your credit score. Understanding the state of your tax liability is the first step to addressing it.
Set Up a Payment Plan
As discussed extensively, a payment plan with the IRS or state tax authority shows mortgage lenders that you are actively addressing your tax debt.
Consult a Tax Professional
Tax issues can be complex, especially when you’re trying to navigate the home buying process. Consulting with a tax professional or an experienced tax attorney can provide valuable insights and advice tailored to your situation. Your tax lawyer can also negotiate for you and show you’re taking the situation seriously and have a plan to deal with it.
Take meaningful steps to manage your debt and improve your overall financial health. This might mean working on improving your credit score, reducing other debt, or saving more for a down payment.
Tips for Selling a Home with a Lien
If you need to sell your home and you have a lien from the IRS, consider the following steps:
Contact the IRS or State Authority
Reach out to discuss your situation and explore your options. You might be able to agree to a payment plan or apply for a discharge or subordination.
Consult a Tax Professional
An experienced tax professional or attorney can provide advice and guide you through the process.
Disclose the Lien to Potential Buyers
Being upfront about the lien can help avoid potential issues down the line.
Choose Your Real Estate Agent Carefully
Work with a real estate agent who is experienced in selling homes with liens. They can provide valuable guidance and support throughout the process.
While owing taxes can create challenges when trying to buy or sell a home, it’s not an insurmountable hurdle. With the right plan, professional advice, and active steps to address your tax debt, homeownership can be within reach. To learn more and get the help you need to buy a house, contact us at Damiens Law Firm, PLLC right away at 601-488-2079. We know how stressful dealing with the IRS can be: and we can help!