Ask the Underwriter: My borrower owes a federal tax debt to the IRS… Is this mortgage deal dead?

Ask the Underwriter is a regular column addressing real questions asked to, and answered by, professional mortgage underwriter, Dani Hernandez. 

Question:

My borrower owes the IRS approximately $16,000 for tax years 2016 and 2017. They have $20,000 in savings, but were hoping to use that money as a down payment to purchase their first home. Is there a way to get them approved without making them pay off the entire tax debt first or is this a dead deal until it is paid?

Answer:

Your borrower does NOT need to pay off the entire tax debt that they owe in order to qualify for a mortgage! Depending on the type of mortgage they are applying for – FHA or Fannie Mae Conforming, they will need to meet certain requirements.

I’ll breakdown what they need to do to qualify for each loan type below and include a set of easy to follow instructions… All you need to do is copy and paste this in an email to your borrower, hit send and add another five-star review to your Yelp! Rating.

If your Borrower is applying for an FHA Loan –

What the Guideline says:

“Federal Tax Debts:

Tax liens may remain unpaid if the Borrower has entered into a valid repayment agreement with the federal agency owed to make regular payments on the debt and the Borrower has made timely payments for at least three months of scheduled payments. The Borrower cannot prepay scheduled payments in order to meet the required minimum of three months of payments.

The Mortgagee must include the payment amount in the agreement in the calculation of the Borrower’s Debt-to-Income (DTI) ratio.

Federal Tax Liens:

Tax liens may remain unpaid if the Borrower has entered into a valid repayment agreement with the lien holder to make regular payments on the debt and the Borrower has made timely payments for at least three months of scheduled payments. The Borrower cannot prepay scheduled payments in order to meet the required minimum of three months of payments. The lien holder must subordinate the tax lien to the FHA-insured Mortgage.”

Instructions for your Borrower:

1. Call the IRS and set up a repayment plan with them. Make sure you ask them to send you a copy of the repayment agreement that specifies the total amount you owe and what the monthly payment amount will be. Keep the letter in a safe place and give it to your lender when you apply for the mortgage.

2. You MUST make THREE CONSECUTIVE payments ON TIME, as agreed to in your repayment plan BEFORE you apply for an FHA loan. So, if you make your first payment on January 1st, the second on February 1st and the third on March 1st… you can apply for the loan on March 1st.

3. When you apply for the loan, make sure to inform your lender about the repayment agreement and to include the monthly payment amount in your liabilities on your loan application. You will need to give them a copy of the repayment agreement you received from the IRS along with proof of the payments you’ve made. You can obtain a payment history from the IRS online or call them and have them send it to you.

4. *This step is ONLY applicable if your Federal Tax Debt has resulted in  Federal Tax LIEN being filed.* You will need to contact the IRS and work with your lender to obtain a Subordination Agreement from the IRS. A subordination agreement simply means that the lien filed by the IRS will be secondary to the FHA’s lien. So should you sell the house or be foreclosed on – the IRS will get paid on their lien only after the lien placed by FHA is paid.

If your Borrower is applying for a Conventional Loan – Fannie Mae

What the guideline says:

“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 (in lieu of requiring payment in full) if:

• There is no indication that a Notice of Federal Tax Lien has been filed against the borrower in the county in which the subject property is located.

• The lender obtains the following documentation:

  • An approved IRS installment agreement with the terms of repayment, including the monthly payment amount and total amount due; and

  • Evidence the borrower is current on the payments associated with the tax installment plan. Acceptable evidence includes the most recent payment reminder from the IRS, reflecting the last payment amount and date and the next payment amount owed and due date. At least one payment must have been made prior to closing.”

Instructions for your Borrower:

If the IRS has filed a Tax Lien against you in the county where the subject property is located – you WILL need to pay off the entire Federal Tax Debt and have the lien released prior to applying for a mortgage.

If there is no federal tax lien filed and you just owe the IRS lots of money, we can make this work:

1. Call the IRS and set up a repayment plan with them. Make sure that you ask them to send you a copy of the repayment agreement that specifies the total amount you owe and what the monthly payment amount will be. Keep the letter in a safe place and give it to your lender when you apply for the mortgage.

2. Apply for a mortgage the same day you set up the repayment agreement with the IRS. Fannie Mae only requires that ONE payment be made BEFORE CLOSING! So, there is no need to wait for the first payment to be made under the agreement, as long as you will make that first payment before your loan closes.

3. Again, remember to tell your lender about the repayment plan and to include the monthly payment amount in your liabilities on the loan application.