FHA Mortgage Guidelines On Collection Accounts And Charge Offs

This Article Is About FHA Mortgage Guidelines On Collection Accounts And Charge Offs

FHA Mortgage Guidelines On Collection Accounts:

  • The Federal Housing Administration (FHA) allows mortgage loan applicants with open unsatisfied collection accounts to get mortgage loan approvals without having to pay the balances of the unpaid collection accounts
  • The U.S. Department of Housing and Urban Development (HUD) is the parent of HUD
  • Borrowers do not have to pay outstanding collections and charged off accounts to qualify for FHA Loans
  • However, many lenders require collections and charged off accounts to be paid in full even though HUD does not require it
  • This is because many lenders have mortgage overlays
  • Lender overlays are additional lending guidelines that is imposed by individual lenders that is above and beyond the minimum HUD Agency Guidelines
  • Gustan Cho Associates has no lender overlays on FHA, VA, USDA, and Conventional Loans

What Are Lender Overlays?

What Are Lender Overlays?

All lenders need to have borrowers meet the minimum agency mortgage guidelines of FHA, VA, USDA, FANNIE MAE, FREDDIE MAC. However, most lenders will have additional lending guidelines of their own called lender overlays. It is not illegal for lenders to have additional lending guidelines that is above and beyond the minimum agency mortgage guidelines. Even though HUD may not require borrowers to pay outstanding collections and/or charged off account, the lender may require it to be paid off as part of their lender overlays:

However, many lenders do have overlays that require open unpaid collection accounts to be paid:

  • What are overlays?
  • Mortgage lender overlays is when a mortgage lender adds additional qualifying mortgage requirements on top of the HUD agency mortgage guidelines on collection accounts
  • Even though HUD does not require borrowers to pay outstanding collections and charged off account, a particular lender can require them to be paid as part of their lender overlays
  • For example, to qualify for a residential mortgage loan via a FHA insured mortgage loan, the minimum credit score required is 580
  • HUD allows borrowers under 580 credit scores and down to a 500 FICO to qualify for an FHA loan with an approve/eligible per automated underwriting system (AUS) with a 10% down payment
  • However, most lenders will not touch any applicants with under 580 credit scores as part of their lender overlays

However, many banks, credit unions, and mortgage bankers may have their own lender overlays where they will set their own minimum credit score requirements.

Common Lender Overlays Imposed By Mortgage Companies

Lenders can have lender overlays on just about anything.

  • Examples of common lender overlays are credit scores and collection accounts
  • Most lenders have lender overlays on credit scores
  • Many lenders are requiring a minimum credit score of 640 when the HUD minimum requirements to qualify for a 3.5% down payment FHA loan is 580
  • Same with collection accounts
  • Borrowers do not have to pay outstanding collections and charged-off accounts to qualify for FHA Home Loans
  • However most lenders will require borrowers to pay outstanding collections and charged off accounts due to their overlays
  • This holds true even though paying outstanding collections and charged off accounts is not part of HUD Agency Guidelines
  • Debt to income ratio lender overlays are also common overlays placed by many lenders
  • The maximum front end debt to income ratio is 46.9% and back end debt to income ratio is capped at 56.9% to get an approve/eligible per automated underwriting system
  • However, most lenders will cap debt to income ratios on FHA loans at 45% to 50% as part of their lender overlays

Gustan Cho Associates is one of the very few national mortgage companies licensed in multiple states with no lender overlays on government and conventional loans.

How Do Underwriters View Outstanding Collection Accounts?

The Federal Housing Administration does not require unpaid unsatisfied collection accounts to be paid in order for a mortgage loan applicant to get a FHA loan.

  • FHA Mortgage Guidelines On Collection Accounts do not require borrowers to pay off outstanding collection accounts
  • FHA Mortgage Guidelines On Collection Accounts have different requirements for non-medical collections, medical collections, and charge off collection accounts
  • However, many lenders have their internal mortgage lending overlays that open collection accounts be paid off in full in order because they have their own lender overlays
  • The reason why most lenders have overlays on unpaid collection accounts is because they are concerned that the unpaid collection accounts can turn into judgments 
  • Gustan Cho Associates has zero overlays

As long as borrowers meet the minimum HUD Agency Guidelines and get an approve/eligible per Automated Underwriting System, we just go off AUS with no other overlays.

UPDATED FHA Mortgage Guidelines On Collection Accounts

As mentioned earlier, you can qualify for a FHA insured mortgage loan with open unpaid collection accounts

  • Prior to several months ago, open unpaid balances on collection accounts were zeroed out
  • There was no impact on applicant’s debt to income ratios with regards to outstanding collection account balance
  • However, updated FHA mortgage guidelines on collection accounts have changed with regards to outstanding unpaid collection accounts

New FHA mortgage guidelines on collections accounts have been implemented on unsatisfied collection accounts on FHA Home Loans.

NON MEDICAL COLLECTION ACCOUNTSFHA Mortgage Guidelines On Medical Collection Accounts

Borrowers with non medical collection accounts with an aggregate unpaid collection balance of $2,000 or more, mortgage underwriters need to take 5% of outstanding collection balance into account towards calculating debt to income ratios.   

For example, lets take a case scenario:

  • Borrowers with total of $10,000 in unpaid collection account balance
  • 5% of the $10,000 or $500 will be counted as a monthly minimum payment
  • This will be used towards the mortgage applicants debt to income ratios
  • Borrowers do not have to pay this but will be used as a hypothetical monthly debt
  • This is the new FHA guidelines on collection accounts and prior to recently, the unpaid collections balance did not matter
  • If the 5% of the outstanding collection account will disqualify the borrower due to high debt to income ratio, there is a second option
  • The second option is for the borrower to get a written repayment agreement with the creditor and agree to a monthly payment amount
  • The agreed upon monthly payment agreement with the creditor will be the monthly payment used versus the 5% of the outstanding collection balance

Those with many unpaid collection accounts can be affected by the new 2020 FHA guidelines on collection accounts. If the 5% of the outstanding collection balance is too much, borrowers should enter into a written payment agreement. Once the written payment agreement is executed, there is no seasoning period for this new agreed upon payment to take effect. It is effective immediately.

Charged Off Accounts

FHA does not require that outstanding charged off accounts be paid in order to qualify for FHA Loans.

  • The 5% rule on outstanding collections balance does not apply with charged-off accounts
  • Charged Off accounts is always has a dollar amount balance on credit reports
  • That balance is the amount charged off
  • Borrowers cannot have credit disputes on charged-off accounts
  • There are times where charged-off accounts are reported as Profit And Loss on credit reports

Charged Off Accounts and Profit And Loss are the same on credit report verbiage.

FHA Mortgage Guidelines On Medical Collection Accounts

Medical collection accounts are treated differently than non-medical collection accounts and are exempt from the 2020 HU Agency mortgage guidelines on collection accounts.

  • Whatever the balance is on unpaid medical collections, a percentage of the unpaid collection account balance will not be used
  • The 5% of outstanding balance towards hypothetical minimum monthly payment is not required on medical collections
  • Medical collections will not affect borrowers debt to income ratios

As mentioned in our earlier blogs, a credit dispute is not acceptable during the mortgage borrowers.

HUD Agency Guidelines On Credit Disputes

Updated HUD Agency Guidelines on credit disputes require borrowers cannot have any non-medical credit disputes on derogatory credit items if the aggregate balance of all outstanding collection balance is greater than $1,000:

  • Mortgage Process will be halted if borrowers have any disputes on non-medical collections, late payments, or other derogatory credit tradelines
  • Credit disputes on non-medical collections, charged off accounts, late payments, or other derogatory credit tradelines that are older than 24 months old are exempt and does not need to be removed
  • Borrowers need to retract the credit dispute in order for mortgage process to continue
  • Unfortunately, when credit disputes are retracted on a derogatory item with balance, scores will most likely drop
  • There have been cases where a credit dispute retraction has dropped applicant’s credit score by almost 100 points
  • Borrowers with collections that have zero credit balances, then the above rules on dispute retraction does not apply
  • Zero balance credit disputes on non-medical collections do not have to be removed

Borrowers can dispute negative derogatory credit items with zero balances as well as medical collections.

FHA Mortgage Guidelines On Collection Accounts And Hypothetical 5% Of Outstanding Collection Balance

How Do Underwriters View Outstanding Collection Accounts?

Borrowers with substantial unpaid collection accounts, HUD guidelines on collection accounts can pose a problem. Even though borrowers do not have to pay outstanding non-medical collections off to qualify for an FHA loan, large collection account balances can pose a debt to income ratio problem. We will explain the potential problems high outstanding collection balances can pose when qualifying for an FHA loan:

Remember that lenders will now require that 5% of the unpaid non-medical collection balance to be used towards calculating borrowers debt to income ratios:

  • A $20,000 unpaid collection account will add an additional $1,000 towards monthly expenses and likely disqualify borrowers
  • The good news is if in this situation, HUD allows borrowers to set up written payment agreement with creditor and use the monthly written payment agreed upon towards calculating the debt to income ratios in lieu of the 5%
  • On the $20,000 unpaid collection issue, if the borrower sets up a  written payment agreement with creditor of $50.00 per month for so many years, then the $50.00 payment will be used towards the monthly expense
  • The $50 dollars per month agreed upon payment agreement with the creditor will be used instead of the 5% of the $20,000, or $1,000 per month
  • There is no seasoning requirements to this rule
  • As long as the payment agreement is into effect, the mortgage lender will use them

Borrowers medical collection accounts with a credit balance, the above 5% rule does not apply.  Credit disputes are exempt on medical collection accounts. Borrowers can dispute medical collections with outstanding balances and are exempt from removing the credit dispute.

FHA Mortgage Guidelines On Collection Accounts: Do Not Pay Off Old Collection Accounts Without Negotiating

Borrowers deciding to pay off an old outstanding collection account, try to negotiate with the creditor. See if they are willing to do a pay for delete. The way this works is the collection agency will agree to delete the derogatory credit tradeline off the credit report in lieu of the agreed payment settlement amount. At the same time, see if they can negotiate the outstanding payment due. Make sure whatever negotiated amount that it is in writing.

  • If deciding to settle on a collection account on pennies on the dollar, make sure that part of agreement is to have the collection agency delete derogatory collection item as part of the payoff
  • As mentioned earlier, the creditor agreeing to delete the collection account from your credit report for the settlement amount is called pay for delete
  • Do not pay off any collections without addressing credit reporting issues
  • Remember that paying an old collection account can reactivate credit derogatory item which will drop credit scores
  • Credit scores can drop as much as 100 points when it is re-activated with a new updated date of last activity

Home Buyers who need to qualify for mortgage with a national mortgage company licensed in multiple states with no lender overlays can contact us at Gustan Cho Associates at 262-716-8151 or text us for faster response. Or email us at [email protected] Gustan Cho Associates has no lender overlays on FHA, VA, USDA, and Conventional Loans. The team at Gustan Cho Associates is available 7 days a week, evenings, weekends, and holidays.

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