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How to get a home loan

Jim Quist is the president and founder of NewCastle Home Loans. He has 20+ years of mortgage lending experience as a business owner, mortgage underwriter, and loan officer. Jim's goal is to help people buy homes.

Jim Quist is the president and founder of NewCastle Home Loans. He has 20+ years of mortgage lending experience as a business owner, mortgage underwriter, and loan officer. Jim's goal is to help people buy homes.



Can I get a mortgage if I owe federal tax debt to the IRS?


Owing federal tax debt makes it harder to get approved for a mortgage, but it’s not impossible to get a home loan with this debt factored in. With some careful planning, you can still get the loan you need despite owing back taxes to the IRS.

As the gig economy booms and side hustles take off, delinquent tax debt is becoming a common issue among potential homebuyers. With more than 11.23 million Americans owing the IRS back taxes, lenders like us are eager to provide clear steps forward for borrowers with delinquent tax debt. 

If you deal with your tax debt early, it won’t totally derail your plans to buy a home. In fact, you’ll have far more paths forward if you handle the debt before it becomes a tax lien. 

If your debt does escalate to a tax lien, your path forward is more limited. Even still, it’s not impossible for you to get approved for a mortgage. 

Regardless of the status of your tax debt, keep in mind that it’s not insurmountable. We’ve outlined the four steps to getting a mortgage if you owe back taxes to the IRS down below. Check out our resources, then schedule a call with one of our loan experts to discover how NewCastle can help you get approved.

 

Step 1: Identify the issue: tax lien or tax debt? 

Step 2: Discuss solutions to resolve your tax debt. 

Step 3: Decide on a plan to repay your tax debt. 

Step 4: Talk with your lender about your mortgage options.

 

 

Step 1: Identify the issue. 

Typically, IRS debt racks up when you underestimate the amount you’ll make in a given year. Not paying enough in quarterly taxes throughout the year means, come April, you might learn you owe more money than you originally set aside to pay your taxes. Letters from the IRS start rolling in, and suddenly your goal of homeownership is in jeopardy.

If you owe the IRS but need a mortgage, your first step is to identify the exact issue at hand. Your federal tax debt will likely be classified first as delinquent tax debt and then, if it remains unpaid, it will become a tax lien. 

Because borrowers with unresolved federal tax debt are ineligible for mortgages, you’ll need to make and execute a plan in order to qualify for the loan you need.

To help you identify the issue at hand, it’s important to understand the difference between delinquent tax debt and a tax lien:

Owing delinquent tax debt means that you owe back taxes to the IRS. Whether you underpaid your taxes or failed to file, the IRS will notify you that you owe, tell you how much you owe, and explain your options for repayment. 

If your tax debt has already been registered as a tax lien, it means the debt has gone unpaid and the IRS has recorded a Notice of Federal Tax Lien in the county where you live. This lien is a public filing that alerts creditors to your debt and gives the government a legal right to your property, including—but not limited to—real estate. 

You have fewer options for repayment at the lien stage, because the debt has already gone unpaid for some time. The lien is also what a lender will likely see as a major red flag, and may cause them to deny your mortgage altogether.

Regardless, understanding the status of your IRS debt will help prepare you for a conversation with your lender, and can help you get back on track toward your future mortgage. 

To move forward with your loan, your next step is to discuss possible solutions toward resolving your debt so you can get approved.

 

Step 2: Discuss solutions to resolve your tax debt. 

Once you understand your debt’s classification, the next step is to contact the IRS and discuss a solution that fits your financial situation and your future plans:

 

A ) Pay off your debt.

The best and fastest way to get rid of delinquent tax debt is to pay it in full before you intend to close on your home. Talk with the IRS to get your payoff amount for the total debt owed, then pay the IRS directly to completely resolve the debt. 

Make sure you talk with your lender about what proof they’ll need that you’ve paid off the debt, and then provide your lender with that documentation, including your payoff amount and payment receipt. The lender will then double-check that the debt is fully paid and that the IRS has released any liens in your name.

With the debt paid outright, you’ve taken care of this potential hurdle to your status as a homebuyer. You’re free to move forward with the mortgage process and receive your loan. 

 
B ) Agree to a payment plan with the IRS.

Depending on your financial situation and how much you owe, you may not be able to manage a full payment to the IRS to resolve your debt. If you can’t repay the entire debt in full before closing, your best bet is to set up a repayment plan with the IRS. 

Talk with the IRS about your repayment options, and pick a plan that will help you proactively address the debt. Keep in mind that it takes some time for the IRS to process and formalize your repayment agreement—so you don’t wait until it’s time to close on your new home to set up the plan. In the case of IRS debt, it’s best to take charge, and to be transparent with your lender about this process.

Once your repayment plan is in place, start making on-time payments per your agreement with the IRS. As you do, you’ll receive paperwork showing that you’ve actively made payments and are keeping up with the agreement. You can provide a copy of the agreement to your lender—including the monthly payment amount and total amount due—along with evidence that you’re up-to-date with the payments.

Your lender will need this proof you’ve begun paying off your tax debt to approve your mortgage. The requirements for established payments differ based on the type of loan you’ll need:

For conventional loans, you’ll need to show proof of at least one payment toward your tax debt before you close on your new home. 

For an FHA loan, you’ll need to show that you’ve made at least 3 on-time payments over a 3-month period in order to establish enough repayment history. 

Keep in mind that this repayment agreement may change your loan calculations and could impact how much you can afford to borrow. Because you have a formal repayment agreement with the IRS that you’ll pay each month, your lender will include this monthly payment amount as part of your monthly debt obligations. This may increase your debt-to-income ratio (DTI) and impact how much you can afford to borrow:

Richard wants to buy his first home, and wants to take advantage of an FHA loan as a first-time homebuyer. Even though he has a full-time job where his taxes are taken out of each check, Richard underestimated the income he’d receive from his side business as a videographer—he owes the IRS $7,500 in back taxes. Richard needs to either pay his delinquent tax debt in full or set up a repayment plan with the IRS before he can get approved for a mortgage.

Because Richard plans to use his savings for the down payment on his new home, he doesn’t want to pay the total debt out of pocket. Instead he sets up a repayment plan with the IRS that will allow him to pay down the debt in monthly installments. When the agreement is in effect, he makes his payments on time each month, and makes sure to keep all documentation related to his repayment. 

After three months of on-time payments, Richard can now be approved for his mortgage, as long as he gives us documentation of his repayment agreement with the IRS and his good payment history. When Richard applies for his loan, he includes a copy of the agreement and his statements with his application documents. 

Richard makes $4,000 each month from his full-time job, and, based on a two-year average, about $2,000 of taxable income each month from his self-employment. We use his total monthly income of $6,000 to determine Richard’s eligibility for the loan.

In terms of debt, Richard owes monthly payments toward his car loan, his student loans, and—now—his IRS repayment agreement. Our loan experts will factor these debts in, along with his future mortgage costs, when qualifying him for the loan:


IRS_LIEN_CHART

 

To make sure that his debt-to-income ratio is still at or below the usual 43% cutoff, we add the total debts together, and divide his total debts by his total taxable income:

$2,110 / $6,000 = 35.2%

This puts Richard’s DTI at about 35%, well below the 43% cap. With his positive repayment history toward his IRS debt and the monthly payment factored in, we can approve Richard’s mortgage and he can move into his new home. 

 

C ) Accept the consequences of ignoring the debt.

If you choose to ignore your delinquent tax debt, the IRS will notify the county you live in and place a lien on your property, including any real estate you already own or would own in the future. 

As we’ve underscored, a tax debt that escalates to a tax lien makes it much harder to get a mortgage. Lien debt takes priority over other kinds of debt— like a mortgage—and so this lien would prevent you from getting a mortgage in your county.

When you owe a debt that escalates to a lien, the lienholder—in this case the IRS—places a public notice that they are entitled to the amount you owe when your property is sold. Lenders want to avoid borrowers with liens in place because it means that the mortgage debt takes second priority to the lien, and the lender could lose out on the loan you agreed to pay because the IRS debt would be paid first. 

Tax liens aren’t reported on credit reports, but it doesn’t mean that your lender won’t discover a lien in your name. As part of the application process, lenders check public records and credit information specifically to verify that a borrower isn’t delinquent on federal debt and doesn’t have a tax lien in place. 

Being up front with your lender before you apply will save everyone time, and allow you to explore any good-faith options you have for getting a mortgage, even with a lien in place. 

Ultimately, your lender wants to have full confidence that you’ll repay the loan, so they’re unwilling to have the mortgage listed as a second-priority debt. Thus, trying to buy a home in a county where you have a registered lien will result in a denial from your lender. With a lien in place, you’ll either have to repay the debt in full or find a workaround. 

And while it’s never ideal to have a lien against your property as a homebuyer, remember: there is a way forward. With some careful planning, you can get ahead of your debt and still qualify for a home loan.

 

 

Step 3: Decide on a plan. 

Once you understand your options to get a handle on your IRS debt, it’s time to get working on a plan. 

  • If you plan to pay off your tax debt:
    Make sure you repay your debt by the time you plan to close on your new home. Talk with the IRS about your repayment amount, submit the payment, and make sure that you’re able to provide documentation that the debt was paid—your lender will want these as part of your loan file. 

  • If you want to set up a payment plan to:
    If you plan to repay your delinquent tax debt in installments, keep your loan type in mind. Touch base with the IRS and discuss your repayment options. Settle on an agreement that works for you, and remember that different loan types require different proof of repayment for your mortgage to be approved:
    • For a conventional loan, you’ll need the formally documented repayment agreement, along with proof of at least one on-time payment following your repayment plan. 
    • For an FHA loan, you’ll need the formally documented repayment agreement, along with proof of at least three months of on-time, monthly payments. This means that you can’t plan to make three consecutive payments close together and still be approved for your FHA loan. Instead, you need to show your lender that you’ve been paying back your debt consistently, on time, for at least three months prior to your closing. 
    As you go through the mortgage process, make sure you stick to your payment plan. Pay in full, pay on time, and slowly chip away at your IRS tax debt. These consistent payments will prove to your lender that you’re serious about eliminating this debt.

  • If you need to work around a tax lien:
    If you already have a tax lien in place, the way forward is a bit more complicated.

    For conventional loans, you’re ineligible for a mortgage until you pay off the lien in full. For FHA loans, you can get approved as long as you set up a repayment plan and the IRS agrees to subordinate their lien, or list their lien as secondary:
    • To get approved for a conventional loan, you can’t plan to buy a house in the county where your tax lien is reported—regardless of any payment plan you might have in place.

      If, for example, the IRS recorded a Notice of Federal Tax in Cook County and you plan to buy a home in Cook County with a conventional mortgage, you’d have to repay your IRS debt in full before closing. The mortgage wouldn’t be approved because the tax lien would take priority over the mortgage debt, and the lender can’t be sure that the loan will be repaid with other debts that take precedence over the mortgage.

      But if you planned to buy a home in neighboring DuPage County—not Cook County—you wouldn’t need to pay the debt in full to be approved for a conventional loan.

      Because tax liens are filed by county, your lien wouldn’t affect a purchase in DuPage County if the lien is filed in Cook County. Your mortgage would be listed as the first priority debt for the property in DupPage County, and a lender could approve your loan with confidence.
Keep in mind: Getting a mortgage in another county doesn’t mean you don’t owe the IRS, or that the tax lien isn’t in place. Your delinquent tax debt stands, and the lien doesn’t go away. You’ll still need to work out a repayment plan with the IRS to resolve the debt.

If you’re applying for an FHA loan, on the other hand, there’s a little more flexibility for your lender.

Once you have a repayment plan negotiated, you can be approved for your mortgage as long as the IRS agrees to subordinate their lien to the lender’s FHA mortgage. Your loan could be approved if the IRS agrees that the mortgage can take first priority as a debt, and the tax lien second priority.

With the payment plan in place, the IRS feels secure that you’re on a path to repayment. In the meantime, your lender is confident that the mortgage will be repaid, because the mortgage has been given the top spot in your debt repayment.

Like the other repayment-plan requirements, make sure you can provide the right documentation to your lender when you apply. Give them a copy of the IRS-approved repayment plan, along with proof that you’ve made at least three months of on-time payments toward your delinquent tax debt.

Your lender will then add these documents to your file and contact the IRS, asking them to subordinate their tax lien and prioritize the mortgage debt in the top spot. If the IRS agrees, then you’re back on track for approval—even if you’re buying in the same county as your current lien.

 

Step 4: Talk with your lender.

Regardless of your situation, getting a mortgage with tax debt can be confusing, and so much depends on the type of loan you need. Plus, each lender will have their own stipulations or requirements when it comes to handling tax debt. 

Being open with your lender about your situation can help you determine the solution that’s best for you—even if you’re just starting out in the homebuying process.

How NewCastle can help:
 

If you’re confident that you’ve got your IRS debt handled and are ready to start your search for the perfect home, let us pre-approve you for your loan. We’ll give you a detailed pre-approval letter that you can submit along with your offer, boosting your chances of your offer’s acceptance.

Start your pre-approval!

 

If you have questions, or want to know about an IRS debt that we’ve not covered here, schedule a time to talk with one of our loan experts—we’ll be glad to walk you through you options. We’ve got the expertise you need to make a smart decision about your next steps. 

Schedule a time to talk

 

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