All too often, loan applicants who carry an unpaid balance with the Internal Revenue Service (IRS) or state taxing entity worry that their credit score will be affected, putting their loan at risk. But they check their credit score, and everything seems great.
However, just because your tax liens don’t affect your credit score, that doesn’t mean they don’t affect your ability to get a loan. When you apply for a mortgage or refinance, underwriters look at much more than your credit score, including any tax liens.
Before 2018, a federal tax lien would appear on your credit report, with lower credit scores being linked to those who had tax liens. In 2017 and 2018, the largest credit bureaus removed tax liens from consumer credit reports as part of the National Consumer Assistance Plan.
This change means that a tax lien filed today will not appear on your credit report and will not factor into your FICO score. This can lead to a false sense of reassurance, since unpaid taxes to the IRS don’t affect credit scores directly. However, the lien still appears in other reports that underwriters will pull when assessing your loan application.
The IRS will generally require a lien determination on balances above $10,000, though whether a lien is filed will be at the revenue officer’s discretion.
Mortgage lenders have access to an entirely separate review system that catches what your credit report misses. This review system will include:
Every mortgage lender requires a title company to conduct a title search on the property before closing. The Notice of Federal Tax Lien is a public record filed with the county or state that has details of your tax lien, and it will appear in this search every time.
When a title search surfaces an unresolved lien, the title company cannot issue a clean title insurance policy. Without title insurance, no lender will fund the loan. This means the loan can’t close, which is why tax liens must be resolved at or before closing, according to the Department of Housing and Urban Development policy handbook.
To assess your application, mortgage lenders require you to sign IRS Form 4506-C, which gives them direct access to IRS tax transcripts. The underwriter can then compare the transcripts to the borrower’s application.
If the transcript shows a balance owed to the IRS, the underwriter flags it, and if returns are missing, the entire application can be paused. Any IRS installment agreement payment that appears in bank statements is also flagged and added to the borrower’s debt-to-income (DTI) ratio calculation.
Any unpaid taxes to the IRS can directly affect your home loan approval.
Underwriters will also review two to three months of your bank statements. Any regular payments made to the U.S. Treasury can signal that you’re on a repayment plan, as this is how IRS installment agreement payments appear.
These payments get added to your monthly debt obligations, which directly affects how much mortgage you can qualify for.
The core issue that a lien presents to your loan is the priority it takes. An unresolved Notice of Federal Tax Lien gives the IRS priority over a new mortgage lender, and so no lender will fund a loan where the government stands ahead of them in the repayment line.
The type of loan you’re applying for determines the solution to this problem. Fannie Mae generally requires the lien to be paid in full at or before closing. Federal Housing Administration (FHA) loans may allow borrowers who have negotiated an IRS payment plan and have at least three consecutive on-time payments to qualify. The monthly payment is also added to the debt-to-income ratio calculation.
The refinance scenario is distinct from a home purchase. When you refinance, your existing mortgage is paid off, and a new one is created. Once the original mortgage is released, the IRS lien that was previously sitting behind the existing mortgage moves to the front of the priority line.
Any lender for your new mortgage will now sit behind the IRS in the priority line, which is why lenders don’t want to fund these loans.
To stop a tax lien affecting your loan, it’s always better to explore your options and take action as soon as possible, rather than after the closing falls through.
Lien subordination allows the IRS to step behind a new mortgage lender in priority. This is the most common path for refinancing and home purchases where a full payoff isn’t possible.
To subordinate your lien, you must apply to the IRS in advance via IRS Form 14134 at least 45 days before closing. The IRS may approve subordination if it determines the arrangement improves its ability to collect what is owed, though approval is not automatic.
An approved IRS installment agreement is another tool for borrowers who cannot pay their full balance before closing. Short-term plans are available for balances under $100,000, and long-term plans are available for balances under $50,000.
For FHA loans, three months of on-time payments may be enough to qualify, while the installment payment is counted in the DTI calculation for conventional loans. Getting an installment agreement in place early gives you the best chance of qualifying.
The installment agreements don’t remove a filed lien, but they do show lenders the balance is being managed.
A lien withdrawal removes the public notice from the record. While the underlying balance still exists, it no longer competes with creditors. This option is available in certain cases, including when direct-debit installment agreements for balances of $25,000 or less are in place.
A discharge allows you to remove the lien from a specific property while leaving it attached to other assets, making it particularly useful when you want to sell a property.
An offer in compromise (OIC) may allow some taxpayers to settle for less than the full amount owed.
If you’re applying for a loan but have a lien in place, it can help to get advice from an experienced tax firm. At Polston Tax, we’ve been resolving IRS liens since 2001, meaning we have the necessary experience to help.
When you hire us, you get a team approach, which can include a tax attorney, case manager, accountant and tax preparer all working together on your case. We’ll also handle all IRS or state taxing entity communication directly, so you don’t have to handle this alone.
What’s more, we know what to expect from the IRS, what strategies work and how to negotiate in a way that protects your home purchase or refinance.
If a federal tax lien is blocking your mortgage or refinance, you need to act now, rather than after the deal falls through.
Polston Tax will review your situation, contact the IRS or state taxing entity on your behalf, and identify the resolution path that works for your circumstances.
To find out how we can help you get the loan you need, contact us today for a free consultation.
