In 2019, over 11 million Americans owed more than $125 billion in back taxes to the IRS. Yes, you can buy a house if you owe taxes, but getting a mortgage can be more difficult if you owe taxes to the Internal Revenue Service (IRS) or state tax authorities.
Lenders take on a significant financial risk when they approve a homeowner’s loan. As part of the mortgage approval process, lenders will carefully evaluate your debt-to-income (DTI) ratio. This ratio compares your monthly debt payments to your gross monthly income. Owing taxes is a debt that adversely affects this ratio.
As the economy fluctuates and job changes and unexpected expenses occur, it is not unusual for people who are careful to live within their means and keep up with their credit card payments to fall behind on their debts and owe income taxes, but this does not necessarily mean they are disqualified from obtaining a mortgage to purchase their dream home.
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What’s the difference between tax liens and tax debts?
Tax debts and tax liens can both affect your ability to purchase and insure a home.
Tax Debt
A tax debt is incurred any time you cannot pay your taxes on time. Your tax debt is the amount of money you owe the IRS after filing your income taxes. If you are unable to pay your taxes and settle your debt by the due date, you have a tax debt. Lenders consider tax debt as a sign that you are unable to pay your debts and, therefore, may not be worthy of credit.
Tax debt can make buying a house more difficult, but not impossible. It is helpful if you can show that you are taking steps toward paying off your debt.
Tax Lien
If you cannot pay your tax debt, the IRS may place a federal or state tax lien on your property. A tax lien is a claim the government makes against your property that entitles the lien holder to halt all activity on the property, including the sale of your home, until you pay your tax debt. If you purchase a new house, the lien is attached to the new property.
A lien is also listed on your credit report. It is public information. It can severely impact your credit score and make it very difficult to get a homeowner’s loan, in addition to other loans or lines of credit.
Mortgage lenders typically require loan applicants to submit their tax returns from the past two years. Tax returns are used to confirm your income and other financial information.
A lender will be very hesitant to approve a loan for a property that has a lien attached to it. They know that the federal or state’s claim to rectify your tax debt may supersede their claim to repay the homeowner’s loan if you sell the property.
A tax lien can also make it difficult to get mortgage insurance. Insuring a home that has a mortgage on it is required by most lenders.
What options do homeowners have when there is an IRS tax lien on their property?
The IRS requires taxpayers to settle their tax debt and remove the lien on their property before it can be sold. One option you may have is to use your home’s equity to pay off the IRS tax debt and remove the lien. Even if you do not have enough equity to pay off the debt completely, you may be able to establish a satisfactory debt repayment plan with the commission.
It is important to acknowledge your tax debt and communicate your plans to the IRS. In a worst-case scenario, if you do not honor your tax debt repayment agreement, the IRS can take your home as collateral to satisfy your debt. However, they are more likely to go after more liquid assets.
Establishing a debt repayment plan with the IRS is an important first step if you have a tax debt and want to secure a mortgage. Be sure to make your monthly payments consistently on time. As you pay down your debt, your DTI ratio will improve, which makes you a better candidate for a mortgage.
An experienced tax attorney can provide advice tailored to your situation.
Can you sell your home when it has a federal tax lien on it?
In many cases, a federal tax lien needs to be paid before you can transfer ownership of your home. If you have equity in your home, the equity can be used to pay off the federal tax debt. If the proceeds from the sale of your home are not enough to satisfy the tax debt, you will be responsible for the rest of it.
If you have a tax debt or tax lien, it is possible to buy a home and get a mortgage.
- Start by evaluating your current finances so you fully understand your ability to pay your tax debt and what payment schedule you can handle.
- Make an appointment with a tax attorney to discuss your current tax situation and develop strategies to improve your financial health.
- Contact the IRS and state tax authorities to discuss a tax repayment schedule. Look at alternative mortgage financial options such as Federal Housing Administration (FHA) loans, portfolio loans, or seller financing if you do not qualify for a conventional loan.
There is no one-size-fits-all guide to estate planning. If you are interested in discussing your estate plan options, schedule a call with us at 855.631.3457 to learn more about how to protect those most important to you.
