FHA Guidelines On Charge Offs and Collections: Guide To FHA Loan Approval

FHA Guidelines On Charge Offs And Collections allow borrowers with outstanding charged-off accounts to qualify for an FHA loan. You may be able to qualify for FHA financing even if your credit report contains charge-offs or outstanding collection accounts. HUD guidelines do not require you to pay outstanding collections or charge-offs before obtaining financing.  FHA loans are the most popular loan program in the United States for first-time homebuyers, buyers with higher debt to income ratio, those with prior bad credit such as collection and/or charged-off accounts, and homebuyers with lower credit scores. It is easier to get an approve/eligible decision from an automated underwriting system (AUS) with FHA loans than it is for any other government and/or conventional loan program.  However, the key to getting FHA mortgage approval is to have been timely on all monthly payments in the past 12 months. Gustan Cho Associates are experts in helping borrowers with prior bad credit, lower credit scores, and outstanding charged-off accounts.

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What Are Charged-Off Credit Accounts?

Disputed Charge-offs and Collections

Charge Off Accounts are creditors who deemed the consumer’s credit account as not collectible and charged it off on their books. Most credit card companies will charge off a consumer who does not pay on their revolving credit card account after six months. Just because a credit account is charged off does not mean that it relieves the consumers of the debt. Charged-off accounts can be sold to third-party collection agencies.

FHA Loan Approval With Charged-Off Accounts

Borrowers can qualify for FHA loans with an outstanding charge off accounts without having to settle the charge offs or pay off the charge off accounts according to FHA Guidelines On Charge Offs. HUD guidelines on charge-offs state that an FHA Borrower does not have to pay off outstanding charge-off accounts nor collection accounts to qualify for an FHA loan.

FHA Guidelines On Charge Offs And Collections Allow FHA Loan Approval With Outstanding Balance

However, many lenders have lender overlays on charge-offs and collection accounts. Charge Offs is when a creditor has tried to collect on a debt owed by a consumer and has written off the debt. A charged-off account does not mean that it relieves the consumer of the debt. The consumer is still liable for the debt and the creditor can always go after the consumer for the amount of the charged-off account.

In the following paragraphs, we will cover and discuss HUD guidelines on charged-off accounts.

FHA Guidelines On Charge Offs And Collections Versus Lender Overlays

There are two types of FHA guidelines for charge-offs and collections.  All lenders require borrowers to meet minimum guidelines established by the US Department of Housing and Urban Development (HUD). HUD administers FHA programs including mortgage guarantees.  However, those agency guidelines are the minimum that borrowers must meet. Mortgage lenders often set stricter underwriting guidelines than required by HUD. The purpose is to reduce the number of loans that end up in default. If a lender has too many loans that end up in foreclosure, even if it follows FHA guidelines, it can lose its FHA approval. 

Understanding The Difference Between HUD Guidelines Versus Lender Overlays

These additional requirements, called “lender overlays,” are not illegal. Most mortgage companies have lender overlays on government and conventional loans. Lenders can be as strict as they want as long as they comply with the minimum standards established for the FHA program and don’t break any fair lending laws.  FHA program guidelines do not require borrowers to pay off collections or charge-offs before funding a loan. But many lenders do require this. Gustan Cho Associates does not improve overlays for FHA financing or any other mortgage program. 

Related: How Do Mortgage Lenders View Charge-offs?

HUD Guidelines for Unpaid Collection Accounts

HUD Guidelines do not require you to pay off all unpaid collection accounts. Its guidelines state:

Collections and judgments may indicate a borrower’s disregard for credit obligations and must be considered in the creditworthiness analysis. All medical collections and charge-off accounts are excluded from this guidance and do not require resolution.

Lenders can ignore non-medical collection accounts if the total of their balances is less than $2,000. You will have to write a letter explaining why your non-medical bills ended up in collection so that the lender can determine if the collection account or judgment was a result of your disregard for financial obligations, inability to manage debt, or extenuating circumstances (not your fault).

Finding a Mortgage Lenders With No Lender Overlays On FHA Guidelines On Charge Offs And Collections

Some individual lenders choose to require you to pay these accounts before closing an FHA home loan.  You can either pay them or find a lender that doesn’t have this overlay.  If your unpaid non-medical collection accounts equal or exceeds $2,000, HUD requires mortgage underwriters to add 5% of the balance to your monthly debt payments when qualifying you for financing. Even if you don’t plan to pay the collection, underwriters will treat the debt as though you will be paying 5% of the balance each month. This can cause your debt-to-income (DTI) ratio to be too high to qualify for financing.  If adding a 5% payment will derail your mortgage approval, you could enter into a written payment agreement with the collection agency. Negotiate a payment low enough to allow you to qualify for your home loan. 

Note that negotiating repayment of an old collection can hurt your credit score because new activity increases the weight of a derogatory entry on your credit report. 

Related: FHA Lender Overlays

Can I Qualify For An FHA Loan With Outstanding Medical Collection Accounts

Medical collections are treated differently than non-medical collection accounts. The 5% rule does not apply. No matter how high the balance is, FHA underwriters do not apply a monthly payment to your DTI calculation.  No matter how much the medical collection account outstanding balance is, FHA guidelines do not require lenders to include a payment in your DTI ratio.  Unless your mortgage lender has an overlay requiring payment of medical collections, underwriters will probably ignore them.

Related: How to Get an Approve/Eligible Decision With Automated Underwriting Systems

What If An FHA Lender Says I Need To Pay The Charged-Off Account For Me To Get FHA Loan Approval

Old collection accounts that the creditor deems uncollectible are often listed as “charged off” on your credit report. You most likely still owe the money. However, FHA guidelines do not require you to pay outstanding charged-off accounts to qualify for a mortgage. If your lender tells you that you must pay a charge-off,  that’s an overlay and not an FHA requirement. You can choose to comply or find another lender. 

Mortgage Guidelines On Disputed Charge-Off and Collection Accounts

Medical Collection Accounts

Sometimes you might dispute a charge-off, collection, or other derogatory entry on your credit report. Automated underwriting software (AUS) normally excludes disputed accounts. If you’re disputing late payments, collections, or charge-offs, and the total of disputed non-medical accounts is less than $1,000, you don’t have to do anything special and your application can go through AUS. If your non-medical disputed balances equal to or exceed $1,000 and are not the result of identity theft, your application must be underwritten manually by a human underwriter. You’ll probably have to explain and document why you’re disputing the account.  If your non-medical disputed accounts are the result of identity theft, credit card theft, or unauthorized use, your application can go through AUS if you document the theft, for instance with a police report.

FHA Loan Approval With Charged Off Accounts

Homebuyers with outstanding collections and charge-offs don’t need to pay them off unless their lender’s overlays require it.  For an FHA home loan with no lender overlays,  call us at Gustan Cho Associates at 262-716-8151 or text us for faster a response. Or email us at [email protected]. The team at Gustan Cho Associates is available 7 days a week, evenings, weekends, and holidays. 

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FHA Lender Overlays

What Are Lender Overlays? Lender Overlays are mortgage lending guidelines that are instituted by the individual mortgage lender and NOT FHA, VA, USDA, FANNIE MAE, nor FREDDIE MAC Guidelines.

FHA Guidelines On Charge Offs And Collections Versus Other Loan Programs

Each mortgage loan program has its own minimum mortgage lending guidelines:

  • FHA GUIDELINES
  • VA GUIDELINES
  • USDA GUIDELINES
  • FANNIE MAE GUIDELINES
  • FREDDIE MAC GUIDELINES

Lenders DO need to meet the minimum mortgage lending guidelines. However, each mortgage lender can have higher mortgage lending standards that surpass the minimum guidelines which are overlays. These additional higher lending standards are called Mortgage Lender Overlays or Investor Overlays.  HUD guidelines state that charge-offs do not have to be paid and do not count. Borrowers with charge offs can qualify for FHA Loans.

Typical Common Lender Overlays On Collections And Charged-Off Accounts

Typical overlays required by mortgage lenders are the following:

  • Charge offs cannot exceed $2,000
  • Charge offs needs to be paid
  • 5% of the charge off balance needs to be calculated on debt to income ratios

Charge offs need a written payment agreement and three months payment seasoning needs to be made by borrowers.

What Are Charge Offs? 

How Can You Get Rid Of Charged-Off Accounts Reporting On Credit Reports?

Here are ways of getting rid of charge offs:

  • Pay off the charge off account
  • Consumers can settle the charge off for less than full face value
  • They can get a paid off settlement letter from the creditor and make sure that the credit bureaus report it as settled
  • Let the statute of limitations expire
  • The statute of limitations on collections and charge offs depends on each individual states
  • Filing Chapter 7 Bankruptcy will discharge the charge offs and you will be no longer liable for the charge off accounts

FHA Guidelines On Charge Offs And Collections: Older Derogatory Credit Has Little To No Negative Effect For Mortgage Approval

The older the charge off account it is, the less likelihood that the creditor will come after consumers for the charge off account. Charge-off accounts can be sold for pennies on the dollar to third-party collection agencies. So until you pass the statute of limitations on collections and charge-offs, the charge-off accounts can still haunt consumers. Remember that FHA Guidelines On Charge Offs state that borrowers do not have to pay off charge-off accounts to qualify for an FHA loan. But the lender may have overlays on charge-off accounts and may not qualify you due to charge-offs.

FHA Guidelines On Charge Offs And Collections: How Are Charge Offs Reported On Credit Reports

How Are Charge Offs Reported On Credit Reports

I get many calls from borrowers who were told by their loan officers that they were aware that FHA Guidelines On Charge Offs do not count but the borrower does not qualify because their charge offs have a balance. The loan officer does not know how to read credit reports.

  • ALL CHARGE OFFS ON CREDIT REPORTS HAVE OUTSTANDING BALANCES REPORTED.
  • The borrowers who came to me for consultation were told that if the charge offs had zero balances on them that they would qualify
  • There are no zero balance charge offs reported on credit reports

You will have an outstanding balance reported on all consumer credit reports.

Mortgage Lender With No Overlays On FHA Loans

With charged-off accounts, there are requirements by HUD, the parent of FHA, that need to be paid. Charged-off accounts with balances do not matter when calculating debt-to-income ratios like collection accounts. 5% of the non-medical collection account balances need to be taken into calculations of debt to income ratios. Not with charged-off accounts Borrowers who are told they do not qualify for an FHA loan due to having charge-off accounts on the credit report, contact us at Gustan Cho Associates at 262-716-8151 or text for faster response. Or email us at [email protected] Borrowers can also email us at [email protected] 7 days a week, evenings, weekends, holidays. Gustan Cho Associates is available to take calls or email mortgage inquiries. We represent a five-star national mortgage lender with no overlays on FHA, VA, USDA, and Conventional loans.

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