Having a tax lien or judgment against you certainly doesn’t make it easy to get a mortgage. But, does it make it impossible?
Luckily, the answer is ‘no.’ You can still buy a house despite having these negative items on your credit report. You just have to know how to go about the process.
The Type of Debt
Certain types of debt can cause more problems than others. Namely, defaulted federal loans pose a serious problem if you want to obtain an FHA, VA, or USDA loan. These loan programs specifically state that you cannot have any previous defaults on federal loans.
This doesn’t mean that gives you free reign to have other types of collections or judgments that are non-federal, though. Lenders look at collections and judgments as poor financial management, which could make it more difficult for you to secure a loan.
So what are you to do? Try the following.
Make Good on the Debt
Your first goal when you have liens or judgments should be to pay the debt off in its entirety. That would be the best-case scenario. If you can wipe the debt clean, it’s like starting with a clean slate. You may still have a little trouble getting a government-backed loan, such as FHA or VA loans, but your chances are better if you pay the lien off.
Of course, not everyone has the means to do this; otherwise, the lien probably wouldn’t be there in the first place.
If this is you, then you have another option.
Obtain an Official Payment Plan
If you can’t pay the debt in full, you can ask for a payment plan. This isn’t a plan you come up with on your own, though. It must be official, meaning from the entity that you owe the money. For example, if you have an IRS tax lien, you must contact the IRS and ask for a payment plan. They will likely make you go through an application process in which they will evaluate your income and assets to determine how much you can afford on a monthly basis.
Once the IRS or any other entity sets up the payment plan it is crucial that you make your payments on time. In order to buy a house with this payment plan in place, you will need to prove 12 monthly on-time payments in a row. In other words, it will be at least one year after you take out the payment plan that you can apply for a mortgage to buy a home. You can prove your payments with a statement from the IRS or whomever you pay or with 12 canceled checks.
How the Payment Plan Affects Your Loan Eligibility
Of course, the payment plan you create is now a debt and that means it gets included in your debt ratio. Even if it does not report on your credit report, lenders will include it to make sure that you are not getting in over your head.
You’ll need it to fit within the following debt ratios for each program:
- FHA 31% front-end and 41% back-end
- VA 43% back end
- Conventional 28% front-end and 36% back-end
- USDA 29% front-end and 41% back-end
Basically, what the lender wants to make sure is that you can afford both the tax lien or judgment monthly payment and all of your other payments, including the new mortgage. They also want to make sure that you continue with your payments so that the lien doesn’t take precedence over the mortgage on your home. If that’s the case, if you defaulted on your loan, the tax lien would get paid first and the lender would be paid second. This could leave the lender without enough money to cover their loss.