I get this call more than people would guess. A self employed owner in Scottsdale had a rough year, filed late, and now owes the IRS. They are paying it down on a plan and they want to refinance, either to lower the payment or to wipe the debt out. They assume the answer is no. Usually it is not.

What decides it is not whether you owe. It is what the debt looks like on paper, and whether anything has been recorded against your house.

A payment plan versus a lien

A payment plan is an agreement. A lien is a claim on your property. They are different problems with different fixes, and lenders treat them differently.

The IRS has several payment plan and installment agreement options, and the one you are on affects the monthly figure the lender will use. Keep the agreement letter, because it is the first thing we will ask for.

How the payment counts

The monthly installment goes into your debt to income ratio like any other loan payment. A $600 payment on a plan reduces the mortgage payment you can afford by roughly the same amount, so a long plan with a small payment is easier to qualify around than a short plan with a big one.

Most lenders also want proof that you are paying as agreed. A common request is a copy of the written agreement plus about three months of on time payments, though the exact number varies by lender and loan type. If you recently entered the plan, waiting out that history can cost you a month or two but it is better than an application that stalls in underwriting. Our guide to why refinances get denied in Arizona covers the other reasons files fail, and our refinance document checklist lists what to gather.

Self employed owners have a second issue. If the debt came from underpaid estimated taxes, your tax returns will show it, and that can shrink the income a lender can use. A bank statement loan or other non traditional documentation sometimes avoids that. We explain those options in our loan programs overview.

When a tax lien is recorded

The IRS can file a Notice of Federal Tax Lien, and when it does, the notice is recorded in the county where you own property. For Maricopa County that means it appears in the Maricopa County Recorder's records, and your title company will find it in the search.

A new refinance loan must sit in first position. A tax lien recorded after your current mortgage is behind it today, but the new loan pays off the old one and needs to take its place. So the lien has to be dealt with in one of three ways.

• Pay it off at closing. The title company gets a payoff letter from the IRS, and the money comes out of the loan proceeds. This is the simplest route if you have the equity.
• Subordination. The IRS issues a certificate agreeing to put its lien behind the new mortgage. You apply on IRS Form 14134, and the IRS suggests allowing at least 45 days.
• Withdrawal or release. Under the IRS Fresh Start rules, a filed lien may qualify for withdrawal when the balance is $25,000 or less, you are on a direct debit installment plan, and you have made several consecutive payments. The IRS explains the rules in its federal tax lien guidance.

Liens and judgments of every kind raise the same title questions. Our guide to refinancing with a lien or judgment on an Arizona home goes deeper on how those clear, and title problems that delay Arizona closings shows how long they can add.

Run your own numbers

Using a cash out to pay the IRS

The IRS charges interest and a failure to pay penalty on unpaid tax. The penalty is generally 0.5% of the unpaid amount per month, and it drops to 0.25% a month while you are on an installment agreement if you filed your return on time. A cash out refinance replaces that debt with a mortgage that is usually cheaper and has no penalty.

Here is an illustrative example, not a quote. You owe $40,000 to the IRS and hold a $400,000 mortgage at 7.0%. A cash out to $440,000 at the same rate raises your principal and interest from about $2,661 to about $2,927, an increase of $266. Paying the IRS over six years would have cost roughly $556 a month before interest, so the monthly drop is close to $290. Closing costs on the new loan come out of that, and you stretch the debt over thirty years, which costs more in total interest.

A cash out refinance lowers your monthly pressure. It does not erase the debt, it moves it into your mortgage.

Use the calculator above to see your own payment. The deeper question is the rate on your existing loan. If you hold a mortgage well below today's rates, giving it up to pay a tax bill rarely makes sense. Our guide to debt consolidation refinance in Arizona walks through that comparison, and how much equity you need to refinance shows the minimum cushion.

Steps before you apply

A short checklist keeps the file from stalling. Get a copy of your IRS account transcript so you know the exact balance. Confirm in writing whether a lien was filed, and when. Keep making every payment on time, because a missed one can undo the history lenders want to see. If you are close to a lien withdrawal threshold, ask about it before you apply. Then talk to a broker who can compare cash out, rate and term, and non traditional options at once, because the right answer changes with the numbers.

When you are ready, Pillar Mortgage Group can walk through your file, and our process page shows how we work. If you are also thinking about your next purchase, browse homes at Arizona Luxury Property Search.

Honest caveat: this is the wrong route if you hold a very low rate on your current mortgage, because a cash out will cost you that rate for years. It is also not a fit if your tax debt is large and unresolved, since a better move may be an offer in compromise or a longer plan with a tax professional first. We are mortgage brokers, not tax advisors, and your tax situation is worth a conversation with a CPA before you borrow against your home to settle it.

Frequently asked questions