Qualifying For FHA Loans With Collection Accounts And Charge Offs

This BLOG On Qualifying For FHA Loans With Collection Accounts And Charge Offs Was Written By Gustan Cho NMLS 873293

There are times when consumers go through hard financial times and get behind on their credit obligations. One of the most common questions I get by my viewers daily is can I qualify for FHA Loans With Collection Accounts that have outstanding balances without having to pay them. FHA does not require borrower to pay off outstanding unpaid collection accounts and balances to qualify for FHA Loans. Many borrowers are told that they need to pay outstanding collection accounts and charge offs in order to qualify for FHA Loans. This is not HUD Guidelines on Collection Accounts but is a lender overlay. Overlays are additional guidelines that the individual lender requires that are above and beyond of HUD Guidelines on collections and charge offs.

Most creditors report the consumer’s credit payment history to the three credit reporting agencies:

  • Transunion
  • Experian
  • Equifax

How Late Payments Affect Credit Scores

Borrowers can qualify for FHA Loans With Collection Accounts and charge off accounts without having to pay them. However, most lenders do want to see timely payments by borrowers in the past 12 months. One late payment reported to the credit reporting agencies can drop a consumer’s credit scores significantly.

  • Multiple derogatory and late payments can easily drop a consumer with a 740 FICO credit score into the 500 FICO category. 
  • When you fall behind on your payment with a creditor, the creditor will most often try to contact you for the first four to six months and if you do not pay or make a payment agreement, the creditor may charge off your debt or contract it with a collection agency. 
  • The collection agency will then aggressively try to collect on the debt. 
  • The collection agency will most likely try to collect on the debt owed and even offer you a settlement. 
  • However, if you do have no source of income or are unemployed, it is obvious that you will not be able to pay the debt, especially if you have large amount of delinquent debts with multiple collection agencies and creditors.

Collection Accounts And Collection Agencies

Most collection agencies will do an online background search on debtors who are delinquent on their debts.

  • If they discover that a debtor is collectible and has assets, they will rigorously try to collect on the debt by suing the consumer where they can get a judgment entered against the consumer and enforce the judgment through wage garnishment, bank levy, and placing liens on the consumer’s assets and property. 
  • Unless the collection agency is confident that the consumer has assets or enough income, the chances are that they will not pursue in suing the individual because it costs a lot of money in attorney and legal fees in suing an individual as well as time. 
  • A judgment is worthless to a creditor if the debtor has very limited income and no assets. 
  • A consumer who has a judgment but no assets is considered to be judgment proof where a debt collector cannot collect on a debtor’s debt due to the debtor being insolvent.

Credit Scores Improve As Collection Account Ages

HUD does not require you to pay off collection accounts to qualify for FHA Loans With Collection Accounts.  Unpaid collection accounts will have less and less of an impact as it ages even with an unpaid collection balance. 

  • It is not uncommon for a consumer with many unpaid older collection accounts with balances to have credit scores of over 700 FICO after a couple of years as long as they have re-established credit. 
  • A bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale can easily drop your credit scores by more than 100 points, however, as time passes, your credit scores will eventually go up. 
  • To expedite higher credit scores, get new credit such as several secured credit cards or other credit accounts. 
  • Re-establishing your credit by adding new credit will negate your bad credit and boost your credit scores. 
  • There are many folks who have unpaid collection accounts, charge offs, bad credit, bankruptcy, foreclosure, deed in lieu of foreclosure, and short sale that have credit scores of over 700 FICO one year later because they have added new credit and have been timely on them.

Can Borrowers Qualify For FHA Loans With Collection Accounts

You can qualify for a mortgage with collection accounts without having to pay them.

  • With FHA loans, collection accounts do not have to be paid to obtain a FHA loan.
  • FHA classifies collection accounts into two categories. 
  • Medical collections and non-medical collections. 
  • Medical collections due not count and you can have medical collection accounts and FHA will disregard them.
  • Non-medical collection accounts do not have to be paid, however, if the aggregate unpaid balance of all of your non-medical collection accounts is over $1,000, then the mortgage lender will take 5% of the unpaid collection account and calculate that amount as part of your debt to income calculation. 
  • For example, if you have a total of $5,000 in unpaid collection accounts from 7 different creditors, the mortgage underwriter will take 5% of the $5,000, or $250, as part of your monthly debt obligation in calculating your debt to income ratios even though you are not making that payment.

Never Pay Off An Old Collection Account With Balance

Many consumers make the big mistake of contacting a dormant creditor and making a payment on the old collection account.

  • Never do this because by paying an old dormant collection account, what you are doing is re-activating the derogatory credit item and the credit bureaus will report it as a brand new collection account and your creditor scores will drop significantly. 
  • Plus the collection account will start as a fresh collection account on your credit report and your statute of limitation period will re-start over again. 
  • Leave old collection accounts alone even though you have an unpaid credit balance on it. 
  • Chances are if the collection account is old, you already passed the statute of limitation period and you are not liable for that debt. 
  • Derogatory credit items need to be removed by the credit bureaus 7 years after the date of last activity by federal law with the exception of bankruptcy, which remains on your credit report for a period of 10 years from the discharge date.

Charge Off Accounts

Charge off accounts do not count and home buyers can qualify for a FHA loan with charge off accounts no matter how much the charge off account balance is.

Why Do Some Mortgage Lenders Ask To Pay Off Collection Accounts?

FHA guidelines are minimum lending guidelines and mortgage lenders do not have to just go off minimum lending guidelines.  Mortgage lenders can impose their own lender overlays on their mortgage loan borrowers.  If you go to a mortgage lender and they tell you that you need to pay off old collection accounts, then you know that they have their own lender overlays.  If that is the case, give me a call or email me at gcho@gustancho.com or at 262-716-8151.  I am a mortgage banker with no lender overlays and just go off FHA lending guidelines.  You can also apply online for a fast pre-approval by clicking APPLY NOW and I will get alerted right away.

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The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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