Can You Get a HELOC with a Tax Lien?

The home equity line of credit is powerful 2nd mortgage but securing a HELOC can become complicated when a homeowner has a tax lien—a legal claim imposed by the government on a property due to unpaid taxes. We published this article to determine whether it is possible to obtain a HELOC with a tax lien, the challenges involved, potential solutions, and key considerations for homeowners.

Understanding Tax Liens and HELOCs

A tax lien is a legal claim placed on a property by a government entity, such as the Internal Revenue Service (IRS) or a state tax authority, when a taxpayer fails to pay owed taxes. These taxes could include federal or state income taxes, property taxes, or other obligations. Once a tax lien is filed, it attaches to the property, making it difficult to sell, refinance or add a home equity line of credit without addressing the debt. Tax liens also appear on credit reports, negatively impacting credit scores and signaling financial distress to lenders.

According to the IRS, tax liens take priority over most other claims, including mortgages, meaning that in the event of foreclosure, the government is paid before other creditors. This high-priority status makes lenders cautious when considering HELOC loans and 2nd mortgages for properties encumbered by tax liens, as their ability to recover funds in case of default is compromised.

HELOC Requirements and Tax Liens

To qualify for a HELOC, lenders typically evaluate several factors, including:

• Credit Score: Most lenders require a minimum credit score of 620–680, though some may demand higher scores for favorable terms.

• Debt-to-Income Ratio (DTI): A DTI below 43% is generally preferred, indicating the borrower can manage additional debt.

• Loan-to-Value Ratio (LTV): Lenders often require an LTV ratio of 80% or less, meaning the combined mortgage and HELOC balance should not exceed 80% of the home’s appraised value.

• Equity: Sufficient home equity (typically 15–20% of the home’s value) is necessary.

• Clear Title: The property must have a clear title, free of liens or encumbrances, to serve as collateral.

A tax lien directly affects the “clear title” requirement. Since the lien is a legal claim on the property, it clouds the title, making it risky for lenders to approve a HELOC. Additionally, a tax lien often lowers the homeowner’s credit score, further complicating eligibility by increasing perceived risk.

Can You Get a HELOC with a Tax Lien?

In most cases, obtaining a HELOC with an active tax lien is extremely difficult but not entirely impossible. The feasibility depends on the lender’s policies, the specifics of the tax lien, and the homeowner’s financial situation. Below are the primary factors influencing the possibility:

1. Lender Policies

Traditional banks and credit unions typically have strict underwriting criteria and are unlikely to approve a HELOC if a tax lien exists. However, some non-traditional lenders, such as private or hard money lenders, may be more flexible. These lenders often charge higher interest rates and fees to offset the risk of lending to borrowers with tax liens. Online lenders or those specializing in subprime loans may also consider applications, but terms are often less favorable.

2. Type and Status of the Tax Lien

The nature of the tax lien matters. For example:

• Federal Tax Liens: IRS liens are particularly challenging because they take precedence over other claims. However, if the homeowner has entered into a repayment plan (Installment Agreement) with the IRS and is making consistent payments, some lenders may consider this a mitigating factor.

• State or Local Tax Liens: These may be viewed as less severe, depending on the amount owed and the jurisdiction’s priority rules.

• Subordination: In rare cases, the IRS or state may agree to subordinate the tax lien, meaning it takes a lower priority than the HELOC. Subordination requires a formal application and approval, which is not guaranteed.

3. Homeowner’s Financial Profile

If the homeowner has a strong credit score (despite the lien), low DTI, and significant home equity, some lenders may be more willing to overlook the lien or work around it. Demonstrating a stable income and a history of resolving financial issues can also help.

4. Paying Off or Resolving the Lien

The most straightforward way to qualify for a HELOC is to pay off the tax lien in full, thereby clearing the title. If paying the full amount is not feasible, negotiating a settlement or entering a repayment plan may satisfy some lenders. Alternatively, if the lien is small relative to the home’s value, a lender might allow the HELOC proceeds to be used to pay off the lien at closing, though this is uncommon.

Challenges of Getting a HELOC with a Tax Lien

Several obstacles make obtaining a HELOC with a tax lien challenging:

• Risk to Lenders: A tax lien increases the likelihood that the lender’s collateral (the home) could be seized or compromised, reducing their willingness to lend.

• Credit Impact: A tax lien can lower credit scores by 100 points or more, pushing borrowers below the minimum threshold for HELOC approval.

• Higher Costs: Lenders who approve HELOCs with tax liens often charge higher interest rates, origination fees, or require larger equity cushions to mitigate risk.

• Title Issues: A clouded title prevents the lender from securing a valid lien on the property, a critical component of HELOC approval.

Strategies to Improve Chances 

Homeowners with tax liens can take several steps to improve their chances of securing a HELOC:

1. Resolve the Tax Lien: Pay off the lien or negotiate a settlement with the IRS or state. Even partial payment or a repayment plan can demonstrate good faith.

2. Seek Subordination: Apply for lien subordination to prioritize the HELOC over the tax lien.

3. Work with Specialty Lenders: Explore options with private lenders or those accustomed to high-risk borrowers.

4. Improve Credit: Address other credit issues, such as paying down credit card balances, to offset the lien’s impact.

5. Consult a Professional: A tax attorney or financial advisor can provide guidance on resolving liens and navigating lender requirements.

Alternatives to a HELOC

If a HELOC is unattainable due to a tax lien, homeowners can consider alternatives:

• Personal Loans: Unsecured personal loans don’t require a clear title, though they often have higher interest rates and lower borrowing limits.

• Cash-Out Refinance: If the lien can be paid off with the proceeds, a cash-out refinance might be an option, though it also requires a clear title.

• Home Equity Loan: Similar to a HELOC, home equity loans may face the same lien-related challenges but could be viable with certain lenders.

• Borrow from Family or Friends: A private loan from a trusted individual may bypass traditional lending requirements.

Taking out a HELOC with a tax lien is a challenge due to the lien’s impact on the property’s title, the homeowner’s credit, and the bank or mortgage lender’s risk assessment. While it is not impossible, it typically requires resolving the lien, negotiating subordination, or working with specialized lenders who accept higher risks. Homeowners should carefully weigh the costs and benefits of pursuing a home equity line of credit this situation and consider alternative financing options. Consulting with tax and financial professionals can provide clarity and improve outcomes.

References

Internal Revenue Service. (2024). Understanding a federal tax lien. 

RefiGuide. (2024). What is a HELOC loan? 

Forbes Advisor. (2023). What is a tax lien and how does it affect you?