Is an IRS Repayment Plan a Hard Stop for Mortgage Qualifying_

Whether you filed your completed taxes this April or an extension, you should already know your tax liability for the past year. If, despite your withholding or quarterly payments, you owe more than you can pay all at once, don’t panic. It’s not the end of the world even if you’re planning on applying for a mortgage right now.

It’s always been possible to obtain a mortgage while you’re on a repayment plan for past tax liability by getting an FHA mortgage. FHA loans, insured by the Federal Government, require borrowers to pay the ongoing premiums on an insurance policy that benefits the lender in mortgage default. These loans aren’t attractive to borrowers with A+credit and the cash to make a sizeable down payment, and now there’s another option.

New Game in Town

As of January 2018, borrowers with IRS repayment agreements can qualify for a Fannie Mae conforming loan. (See details of conforming loan amounts in this blog post.) Fannie Mae is a government-sponsored enterprise (GSE) that purchases existing mortgage loans from lenders. The other GSE, Freddie Mac, has not revised guidelines allowing for open income tax repayment plans.

From their guidelines, Fannie Mae will now allow:

“When a borrower has entered into an installment agreement with the IRS to repay delinquent federal income taxes, the lender may include the monthly payment amount as part of the borrower’s monthly debt obligations (instead of requiring payment in full).”

Your monthly payment to the IRS is added to your other monthly payments when calculating your debt-to-income ratio. As long as the total of your monthly obligations, plus your monthly IRS payment, does not exceed 45% of your gross monthly income, you’re eligible for loan approval (see this blog post for a full explanation of the debt-to-income ratio calculation.)

Fannie Mae also requires:

  • You disclose the repayment plan and the monthly payment amount on your loan application.
  • You don’t have a Notice of Federal Tax lien filed against you in the county where the property is located.

Also, per Fannie Mae, you must provide the lender with:

  • An approved IRS installment agreement with the terms of repayment, including the monthly payment amount and total amount due; and
  • Evidence you’re current on the payments associated with the tax installment plan.

A critical difference between FHA and Fannie Mae guidelines is the number of months of payment history required to qualify.  For FHA, three monthly payments are needed, and they can’t be prepaid to qualify. Fannie Mae requires at least one payment be made before the loan closes.

What You Need to Do

Along with the payment history requirements, there are a few other things you can manage that will help your eligibility.

Avoid having a lien filed by proactively contacting the IRS to request a payment plan as soon as you realize you can’t pay your balance in full. If you don’t act and the IRS files a Notice of Federal Tax lien, you’ll either have to pay the entire balance to be approved for a conventional loan or consider an FHA loan.

Request the longest term available with the lowest monthly payment when you’re working out the details of the repayment agreement with the IRS. A smaller monthly payment will impact your debt-to-income (DTI) ratio the least. If your DTI is 44% without the IRS monthly payment, determine how can pay and still keep your DTI under 45% to qualify.

For example: if your salary is $150,000/year, your gross monthly income (before taxes) is $12,500.  If your DTI is 44% of that monthly income, before the IRS payment (including the full mortgage payment), your total monthly debt is $5,500.  With a maximum of 45% DTI allowed, your IRS payment must be no greater than $125/month. (45% of $12,500 equals $5,625)

But What If This Happened?

If there’s already a tax lien filed against you and don’t have the funds to pay off the balance of the taxes you owe, an FHA loan is your next option. Make sure you can prove you’ve made three months of payments, and request that the IRS subordinate their tax lien to the new mortgage loan.

Liens are placed on the property in the order that they occur. So, unless the IRS issues a subordination agreement, the mortgage lien would be in the second position. Subordinating the IRS lien means that it won’t be the first lien paid off when the property is sold in the future. The process and requirements to subordinate an IRS lien are found here.

If you’ve had multiple years of unpaid tax liability and repayment plans with the IRS, and the underwriter can see that, your loan won’t be approved automatically, even with Fannie Mae’s new guideline.  A pattern of underpaying income taxes, with a growing balance and payments, is considered a red flag.

A red flag is something that causes the underwriter to become concerned while reviewing a loan file. If an underwriter sees something they consider a red flag, they’ll request additional information.  This may include a written explanation regarding the circumstances that produced the multi-year tax liability and the steps you’re taking to prevent it going forward.

The answer to whether you can qualify for a mortgage if you’re on a tax repayment plan is yes, as long as you meet the above conditions and are applying for a conforming loan amount. If you’re seeking a jumbo loan, your options are limited to paying off the full tax liability before applying for a mortgage.

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