Owing back taxes isn't an automatic deal-breaker when you apply for a Federal Housing Administration (FHA) mortgage. As long as you're paying off your debt, the fact that you got into tax trouble doesn't disqualify you. Potential lenders will simply treat your tax debt as they would any other loan or credit card obligation.
Like all debts, however, your tax debt does impact your overall credit rating. As such, it could impact your chances of FHA loan approval in the same manner as any other debt.
Although the back tax payments alone usually won't disqualify you, that tax debt along with your other debts can affect your credit rating and debt-to-income ratio, thus reducing your chances of getting an FHA loan.
Debt-to-Income Ratio Requirements
Qualifying for an FHA loan hinges on the ratio of your debt payments to your income. To qualify for an FHA mortgage, the total amount of your monthly housing payment cannot exceed 31 percent of your income. The amount of your monthly housing expenses and your other debts combined cannot exceed 41 percent of your income.
This second ratio is where your back taxes become a factor. The monthly payments you make toward your back tax bill get included when calculating your debt-to-income ratio. If these payments push your ratio over 41, you'll need to pay off the tax debt or another bill in order to qualify for an FHA loan.
Credit Score Requirements
Even with an FHA-backed loan, you need a credit score your lender can live with. FHA loans require a lower credit score than other mortgages, but as of 2019, you'll still need a FICO score of at least 500 in order to qualify. Fortunately, making payments on back taxes doesn't create the black mark on your credit that a bankruptcy does.
To the credit bureaus, an IRS payment plan is just one more credit account. If, however, things reach the point where the IRS puts a lien on your current house, you're not going to get an FHA loan until you and the IRS strike a deal on your debts and you've made timely payments toward that deal for at least three months.
Other Loan Requirements
Cutting a deal to pay your back taxes isn't quite enough to seal the deal on your FHA loan. You must prove that you not only made a deal but that you're living up to it. Missing tax debt payments or making late payments both count against you. Lenders want to see you pay all of your debt as agreed, not just your tax bill. Any missed or late payments to any of your creditors could result in an FHA loan denial.
Your credit history needs to show you consistently pay your bills on time. If you've run into some problems, get back to making consistent payments as soon as you can. You'll need a two-year history of timely payments to qualify for an FHA loan.
Making It Work
If back tax bills or other debt payments create a debt-to-income ratio that results in a loan denial, don't give up just yet. You can work around this situation by making a larger down payment. This reduces the amount you need to borrow, which reduces the amount of your housing payment. This, in turn, reduces your debt-to-income ratio.
You may also have the option of raising your allowable debt-to-income ratio if you can show you have substantial cash reserves or a net worth large enough to pay off the mortgage. If you have anything you think can increase your bargaining power, throw it on the table and see if it helps.
- Credit.com: I Have Unpaid Debt on My Credit Report. Can I Still Get a Mortgage?
- The Lenders Network: FHA Loan Requirements – How to Qualify for an FHA Loan
- FHA News and Views: Can I Get An FHA Home Loan If I Owe Back Taxes?
- Bankrate: FHA loans – Your complete guide to FHA loans
- FHA.com: Common FHA Mortgage Questions
- Nerd Wallet: FHA Loan Credit Score Requirements for 2019