Can I Buy a House if I Owe Back Taxes?

Buying a house is an exciting milestone in life, representing stability, investment, and the fulfillment of a dream. However, for individuals who owe back taxes, the path to homeownership can seem uncertain. It’s essential to understand the implications and challenges associated with buying a house while having outstanding tax debt. In this article, we will explore the factors to consider and strategies to help you navigate this unique situation. 

Understanding Back Taxes 

Before diving into the home buying process, it’s crucial to understand what back taxes are. Back taxes are unpaid taxes from previous years, either due to underpayment or non-payment. The IRS may assess penalties, interest, and other charges on the outstanding amount, which can accumulate over time. While it’s not impossible to buy a house while having a tax balance, owing back taxes can potentially hurt your ability to qualify for a mortgage. 

Addressing Back Taxes 

Addressing your back taxes is crucial before attempting to buy a house, especially since most lenders will not want to approve you for a mortgage if you haven’t made any attempt to resolve your tax debt. This is because if you owe back taxes and own a home, the IRS can place a tax lien on your property. A tax lien gives them first dibs at the home if you do not pay your back taxes. In other words, your lender would incur a major financial loss. Here are a few steps to help you address your tax debt: 

1. Evaluate your options. The IRS may offer options for resolving back taxes, such as installment agreements, offers in compromise, or currently not collectible status. Consult a tax professional to determine the best course of action for your situation. 
2. Establish a payment plan. If you can’t pay the entire amount upfront, consider setting up a payment plan with the IRS. This allows you to make monthly payments towards your tax debt over an extended period. Demonstrating a consistent repayment history will show lenders your commitment to resolving your financial obligations. 
3. Consider professional help. If your tax debt is complex or substantial, seek the assistance of a tax professional. These professionals can negotiate with the IRS on your behalf and help you explore potential resolution options. 
4. Prioritize tax debt repayment. Make it a priority to pay down your tax debt as much as possible. Dedicate a portion of your budget to regular payments, aiming to reduce your overall tax liability over time. 

Qualifying for a Mortgage While Owing Back Taxes 

Once you’ve made significant progress in addressing your back taxes, you can focus on qualifying for a mortgage. Here are a few considerations: 

Credit Score and History

Your credit score plays a crucial role in the mortgage application process. Maintaining a good credit score and demonstrating responsible financial behavior will enhance your chances of securing a mortgage. 

Debt-to-Income Ratio

Lenders assess your debt-to-income ratio (DTI) to evaluate your ability to manage mortgage payments. This ratio compares your total monthly debt payments to your gross monthly income. If you’re making payments on an IRS installment agreement, these payments will be factored into your DTI. A high DTI ratio could hurt your chances of getting approved for a mortgage, as it indicates you may struggle to manage additional debt. Paying down your tax debt and minimizing other outstanding debts can improve your DTI ratio and increase your chances of mortgage approval.  

Documentation

Prepare thorough documentation of your financial situation. Be sure to include proof of income, tax returns, and documentation related to your tax debt repayment. This documentation will help demonstrate your financial stability and responsible approach to resolving your tax obligations. 

Outstanding IRS Tax Liens 

If the IRS has placed a tax lien on your assets, it becomes a public record and signals to creditors that you have unpaid debts. Most lenders will require you to resolve the lien before approving a mortgage. You can do this either by paying off the debt or negotiating a payment plan with the IRS. If the IRS has placed a lien on your property, you may be able to request a Certificate of Discharge via IRS Form 14135. While this does not make the lien go away, it does offer a promise that the IRS will be paid once the assets are sold. This scenario is common when taxpayers are attempting to sell their home with a tax lien attached to it, to purchase another home. Unless the lien is taken care of, mortgage lenders are unlikely to move forward. 

Alternatives to Conventional Mortgages 

Qualifying for a mortgage while owing back taxes can depend on the type of loan you are seeking. For example, FHA loans are more desired for buyers because they allow you to buy a home with looser financial requirements. If you are seeking an FHA loan but owe back taxes, you must have made at least three payments to an IRS installment agreement, and meet other conditions, to be approved.  In addition, some private or non-bank lenders may be willing to work with borrowers who have tax debt, but they often charge higher interest rates and may require larger down payments. 

Owing State Taxes 

Owing state taxes can also affect your ability to buy a home, though the specifics vary by state. Like federal back taxes, state tax agencies may place liens on your property for unpaid state taxes, which could complicate your mortgage approval process. Lenders are typically wary of any outstanding liens, whether federal or state, as these liens take priority over the mortgage in case of default. Some states also report unpaid taxes to credit bureaus, which can negatively impact your credit score. To improve your chances of securing a mortgage, it’s advisable to enter into a payment plan with the state tax authority, similar to an IRS installment agreement. 

Getting Approved for a Mortgage While Owing Back Taxes 

If you do manage to get a lender to approve you for a mortgage while owing back taxes, you should expect your tax bill to have an effect on your monthly payments. Because you will be considered a high-risk borrower, your interest rate will likely be higher than that of a low-risk borrower. You may also be required to put down a much larger down payment if the lender feels this might mitigate the risk that you come with. It goes without saying that these terms are not favorable for buyers, and seeking tax help from a professional can help lower the cost and stress associated with buying a home. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.  

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