For mortgage lenders, your debt is not a deal-breaker – up to a certain point. Even the nasty stuff like judgments and collections won’t necessarily keep you from getting a mortgage.
But life can get a bit more complicated when it’s Uncle Sam you owe.
Failing to pay your federal income taxes can lead to theInternal Revenue Service placing a lien on your property or your assets. These legal tools protect the government’s ability to get its money. They also set off alarm bells for lenders.
The good news is that the presence of a federal tax lien doesn’t automatically ruin your home-buying chances. It’s almost always more a matter of what you’re doing to make the lien go away.
Federal tax liens hit a peak of 1.1 million in the 2010 fiscal year, according to the IRS taxpayer advocate service. New initiatives meant to help delinquent taxpayers avoid liens have since cut into that peak considerably.
But hundreds of thousands of Americans are still hit with one each year. Once you’ve received official notice, you have 10 days to pay before the IRS can file for a lien.
These public records also find their way to your credit report. Tax liens can make it tough to secure many types of credit and even linger after a bankruptcy discharge. Federal debt can be especially problematic when you’re seeking a government-backed mortgage like an FHA or VA loan.
The best solution is to pay off the lien before you fill out a loan application. But if that’s not something you’re able to do, you still might be able to forge ahead, provided you’ve actually tried to make a dent in that debt.
Lenders can view liens differently depending on the loan type and other factors. But in general, military borrowers with a tax lien, for example, may be able to obtain VA mortgage preapproval if:
- They have an acceptable repayment plan with the IRS and have made on-time payments for at least the last 12 consecutive months.
- They can satisfy all debt-to-income (DTI) ratio requirements with that monthly tax repayment included.
- They note their outstanding tax lien on the standard loan application.
Even with all of those conditions, consumers with tax liens may have some additional hurdles to clear to satisfy underwriters.
A tax lien can make it difficult for lenders to process a loan file using an automated underwriting system. The alternative is what’s known as a “manual underwrite,” which can involve a closer look at your financials and tighter requirements, such as a lower allowable DTI ratio.
So, if you’re a prospective homebuyer with a tax lien, a good first step is making sure your track record shows at least a year’s worth of on-time payments. Pay it off in full if possible, but if that’s a tall order, know that you might have diminished purchasing power and a rockier road until the slate is clean.
In the meantime, you should also be keeping tabs on your progress by checking your credit reports regularly (which you can get for free once a year from each of the three major credit reporting agencies), and monitoring your credit scores for increases — or drops. Taking an active role in your credit can help you get on track to buy a home, especially when you’re facing certain financial hurdles.