If you want to get a mortgage for a new home or refinance an existing mortgage, a bank or other lender will review your finances. The most important part of this process is the lender verifying your income and assets, as well as confirming what debts you have outstanding.

This means getting approved for a mortgage refinance or a new mortgage will be much harder if you are having financial struggles, like losing a job. But can you refinance a mortgage or buy a house if you owe taxes or have unfiled tax returns with the IRS? The short answer is “sometimes,” although getting rejected is far more likely, and any approval will be more difficult and more expensive. 

How Unfiled IRS Tax Returns Affect Home Purchase or Refinance 

If you want to apply for a mortgage loan so you can buy a house, you apply for a purchase mortgage. If you already own a home that’s subject to a mortgage and want to change the terms of the mortgage (such as interest rate, loan term, and/or monthly payment), you apply for a mortgage refinance. Although there are different reasons to obtain a new mortgage or refinance a current one, the general process for getting either one is similar.

The biggest reason why having unfiled tax returns can make it harder to get a mortgage is because many lenders want you to provide one or more years’ worth of income tax returns. Most mortgage lenders make this request to verify your income. Tax returns are especially important if you’re self-employed and don’t have an employer who can verify your income.

If you don’t have tax returns, then lenders may decide not to approve your mortgage loan or refinance request. In some cases, this will be because the lender views your inability to provide the necessary tax returns as a sign that you’re a credit risk they want to avoid. In other situations, it may be a loan application requirement, such as when applying for certain FHA (Federal Housing Administration) or VA (U.S. Department of Veterans Affairs) mortgage loans.

If a lender is willing to look past your lack of tax return documents and can verify your income in other ways (such as bank statements), they may still view you as a high-risk borrower. This could result in higher interest payments. So keep in mind that unfiled tax returns could make your mortgage loan more expensive, even if it doesn’t prevent you from getting one. 

Note that it may be easier to refinance without tax returns than to get a new loan. When you refinance with the same lender, you have an established relationship with them, making them more likely to approve the refinance request with less information. 

How Unpaid Taxes Affect the Mortgage Loan Approval Process

Unpaid taxes can affect your ability to get a mortgage or refinance in different ways, depending on the situation. If you’ve worked with the IRS to set up a payment plan or installment agreement, then the lender will most likely view your payments to the IRS as another type of monthly debt expense, like a car loan or credit card payment.

The money you send to the IRS will be factored into calculating your debt-to-income ratio. This is the ratio between how much money you make and how much money you owe. If the debt part of this ratio gets too big compared to your income, the lender may decide not to approve your mortgage refinance or loan request.

Getting a Mortgage When You Have a Tax Lien Against You

If your tax debt results in a tax lien, this has a bigger chance of preventing you from getting a mortgage. This is because the lien indicates that the IRS is a creditor that will compete with the bank should the IRS try to collect the tax debt from you. Also, current tax liens attach to future property, including a new home.

Banks deciding whether to approve a home loan won’t like this because they want to be the only creditor that can go after your home after a mortgage default. If they find out they’ll have to share proceeds from a foreclosed home with the IRS, and they will likely decline to offer you a mortgage. If they do somehow offer you a mortgage loan, it’ll be smaller, have a higher interest rate, and/or require a larger down payment. 

How Do Lenders Know You Owe Taxes to the IRS?

There are three primary methods banks and other financial institutions use to discover unpaid tax debts. First, the mortgage loan application will ask about any outstanding debts and loans. If you have past-due taxes, the bank will want you to mention it during the application process. Hiding debts is considered loan fraud. You have to disclose this information if requested.

Second, the bank will search public records to see if there are any tax liens on your property. IRS tax liens no longer show up in your credit history, but they are public records, so they can be easily found during the loan underwriting process.

Third, the lender will ask to review your past years’ tax returns. Recall that the primary reason to request tax returns is to verify income. But lenders also want to see these returns to see if you have any tax issues with the IRS.

Banks will sometimes miss the fact that you have unpaid taxes, but this will typically occur because you’ve taken steps to hide the tax debt and/or lie during the loan application process. If you do this, it could constitute mortgage loan fraud. In this situation, you have more to worry about than a rejected mortgage loan application. 

A Quick Note About Tax Liens and Mortgage Refinances

As mentioned earlier, the application process for a purchase mortgage or a mortgage refinance is similar, at least with regard to unfiled tax returns and tax debts. However, one important difference comes in when dealing with IRS tax liens and cash-out mortgage refinancing.

A cash-out mortgage refinance allows you to turn the equity in your home into cash in return for a bigger mortgage balance. Unfortunately, if the IRS has a lien against your home, most lenders won’t be willing to refinance. However, if you plan on using that cash to pay unpaid taxes, the IRS may be willing to subordinate its lien. In plain English, this means the IRS will allow the bank to have priority over the IRS in case the bank has to foreclose on your home.

The IRS is willing to do this because it allows you to pay back some or all of your tax debt. And if your tax debt is gone, the IRS no longer has a reason to keep its tax lien. To begin this subordination process, you’ll need to complete Form 14134, Application for Certificate of Subordination of Federal Tax Lien. 

Practical Considerations with Unpaid Taxes or Unfiled Tax Returns

As helpful as the above information is when deciding if you’re eligible to get a purchase mortgage or refinance, you need to avoid missing the forest for the trees. In other words, even if you have your tax returns filed or don’t owe anything to the IRS, that doesn’t mean you’ll automatically get approved for a home mortgage.

Alternatively, just because you owe money to the IRS or are missing a few tax returns doesn’t automatically mean a bank won’t issue you a loan. The question you should be asking isn’t, “If I don’t have _________ information, can I get a mortgage?” The real question should be, “Will the lender think I’m financially healthy enough to afford a mortgage that may take 10, 20, or 30 years to pay back?”

In answering that question, you need to remember that banks and other lenders may examine other pieces of information when reviewing your loan application. This includes documents such as:

  • Bank statements
  • W-2 forms
  • Pay stubs
  • Alimony or child support payment records
  • Retirement account statements
  • Verification letter from clients (if you’re self-employed)
  • Gift letter (a document that confirms a large cash gift is really a gift and not a loan).

The lender will also review your credit history and credit score to see how well you’ve handled credit. They’ll also determine if any potential creditors could stand in the way of the bank trying to repossess your home should you default on your mortgage. 

Alternatives to Traditional Mortgages for People With Tax Debt

As explained above, most traditional mortgage lenders will not work with you if you have unfiled returns, and they will also be leery about excessive tax debt monthly payments or tax liens. However, there are a few rare alternatives.

  • Buying a home in cash — If you have the cash to buy a home, you don’t need to work with a lender. The seller will not care if you have unfiled returns or unpaid taxes. However, if you have unpaid taxes, be aware that the IRS can come after your assets. If a tax lien already exists, it will attach to your new home. 
  • Getting an owner-finance deal — Some sellers are willing to finance the sale for you. You make them monthly payments instead of the bank. These arrangements are a lot more flexible, and sellers may not care about your tax situation. However, owner-carry deals can be predatory in some cases so make sure that you understand what you’re getting into. 
  • Private lenders — Private lenders including friends and family have much different lending standards than banks. If a private party believes that you can repay, they may offer you a loan, but again, you need to be aware that tax liens can attach to your home. 

Having Issues with the IRS and Want to Apply for a Mortgage?

If you’re looking to refinance your current mortgage or apply for a new one, having unpaid taxes or unfiled tax returns will likely prevent you from getting either. If you do get bank approval, you’ll likely have to pay more money and have to go through a longer and more complicated approval process.

All of this is to say that the quickest and most economical option for most taxpayers is to file any missing tax returns and pay any outstanding debts before applying for a mortgage. If you can’t pay your tax debt in full, try to file and set up a payment plan before the IRS issues a tax lien. 

However, catching up on unfiled taxes is usually easier said than done, but Seattle Legal Services, PLLC can help. We offer free consultations, so it costs you nothing to contact us and learn what we can do for you.