How Your Tax Debt May Impact Your Ability to Buy a Home

How Your Tax Debt May Impact Your Ability to Buy a Home

• Jun 29, 2022

Tax debt can impact many aspects of your financial life, but can they stop you from qualifying for a mortgage? In some cases, yes, your tax debt can be the reason you don’t get a mortgage from a lender. However, tax debt does not automatically bar you from receiving a mortgage either. So what sort of impact does tax debt actually have on your ability to buy a home? Keep reading to find out.

Lender’s Guidelines and Debt-to-Income Ratio

Failing to qualify for a mortgage when you have tax debt usually has less to do with the back taxes themselves and more to do with lender guidelines and debt-to-income ratio. Certain lenders may actually bar anyone with federal tax debt from receiving a mortgage. However, in most cases, the tax debt will simply push you over the lender’s allowable debt-to-income ratio.

When applying for a mortgage, lenders will carefully examine all your debts and all your income sources to determine if you can reasonably afford the monthly mortgage payments. If you have a large tax debt, this will also be included with all of your other debts, and can often make it so that your debts are too high to qualify for the mortgage.

IRS Debt versus State Tax Debt

Many people feel that the IRS tax debt they owe supersedes any taxes they may owe to their state. However, when it comes to qualifying for a mortgage, your state taxes may actually have a bigger impact than your federal tax debt. This is because the IRS has very clear guidelines and regulations for how they collect tax debt, while the state government has a bit more freedom.

Because a lender knows that the IRS cannot seize property without following certain steps, they may feel more secure providing a mortgage to a borrower with federal tax debt. However, most state tax authorities do not have the same due process requirements as the IRS. They can seize property with very little notice to collect on overdue taxes. This makes borrowers with state tax debt a much higher risk than those who owe the IRS money. So, if you have both kinds of debt, it’ll likely benefit you more to pay off your state tax debt first if you hope to qualify for a mortgage.

Mortgages and Tax Liens

Qualifying for a mortgage with a tax lien on your assets is a very different situation from applying for a mortgage loan with tax debt. A tax lien means that your tax debts were left unpaid long enough to trigger collection actions, which may signal to the lender that you’re likely to fall behind on your mortgage as well. If you have a lien on your current home, you may not even be able to sell it without first settling your tax lien; this often makes it impossible for homebuyers to even be able to afford their new mortgage, without the income from selling their first home.

However, even if you don’t have a tax lien on a current property, liens on other asset or levies on your bank accounts are much more likely to preclude you from receiving a mortgage. You may still qualify for an FHA loan, but many other types of mortgage loans will be closed to you due to this unsettled tax debt.

Benefits of Settling Tax Debt before Mortgage Application

If you’re hoping to buy a home soon, it’s a good idea to try to settle your tax debt before you begin the application process for a mortgage. Even simply setting up a payment plan can make an incredible difference in helping you qualify. Not only does this demonstrate a genuine effort to repay what you owe—which is always a good sign to a prospective lender—but it also structures your debt into clear monthly payments that can be used when calculating your debt-to-income ratio.

Additionally, paying down even some of your taxes can lower your debt-to-income ratio and potentially qualify you for a lower interest rate. Even if you qualify for a mortgage with your full tax debt intact, you may only qualify if you agree to a high interest rate; lowering your debt-to-income ratio can often allow you to lower the interest rate on your future mortgage.

If you have tax debts and are worried about how it may impact your ability to qualify for a home loan, contact the IRS Advocates today. We can help you setup a repayment plan or other settlement option with the IRS so that your tax debts are less likely to impact your