FHA Mortgage Guidelines On Collection Accounts And Charge Offs
In this blog, we will discuss and cover the FHA Mortgage Guidelines On Collection Accounts as well as charged-off accounts. Borrowers can qualify for an FHA loan with outstanding collection and charged-off accounts without having to pay them. 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
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 are imposed by individual lenders that are 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?
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 are above and beyond the minimum agency mortgage guidelines. Even though HUD may not require borrowers to pay outstanding collections and/or charged-off accounts, the lender may require it to be paid off as part of their lender overlays.
Why Do Some FHA Lenders Require Collection Accounts To Be Paid?
However, many lenders do have overlays that require open unpaid collection accounts to be paid. What are overlays? Mortgage lender overlays are 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 accounts, 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 an FHA-insured mortgage loan, the minimum credit score required is 580.
Can I Get Approved For FHA Loans With 500 Credit Scores?
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 requirement to qualify for a 3.5% down payment FHA loan is 580. Same with collection accounts.
Getting Approved For FHA Loans With Collections and Charged Off 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.
FHA Loan Approval With High Debt To Income Ratios
Debt to income ratio lender overlays is also common overlays placed by many lenders. The maximum front-end debt to income ratio is 46.9% and the 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 an 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.
FHA Loans With Bad Credit
Many lenders have their internal mortgage lending overlays that open collection accounts be the reason why most lenders have overlays on unpaid collection accounts is that 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 HUD Mortgage Guidelines On FHA Loans With Collection Accounts
As mentioned earlier, you can qualify for an 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 the applicant’s debt to income ratios with regard to the outstanding collection account balance. However, updated FHA mortgage guidelines on collection accounts have changed with regard to outstanding unpaid collection accounts. New FHA mortgage guidelines on collections accounts have been implemented on unsatisfied collection accounts on FHA Home Loans.
FHA Guidelines On Non-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 the outstanding collection balance into account towards calculating debt to income ratios.
For example, let’s take a case scenario:
- Borrowers with a 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 balance of the unpaid collections 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 2022 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.
FHA Loan Requirements On 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 have 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 2022 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 for mortgage borrowers.
HUD Guidelines On Credit Disputes During The Mortgage Process
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: The mortgage process will be halted if borrowers have any disputes on non-medical collections, late payments, or other derogatory credit tradelines.
Credit Disputes Exempt From Being Removed During The Mortgage Process
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 do not need to be removed. Borrowers need to retract the credit dispute in order for the mortgage process to continue. Unfortunately, when credit disputes are retracted on a derogatory item with balance, scores will most likely drop.
Why Removing Credit Disputes Can Drop Credit Scores
There have been cases where a credit dispute retraction has dropped an 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.
Why 5% Of Outstanding Collection Balance Is Used For Debt To Income Ratio Calculations
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 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 a written payment agreement with creditors 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 the 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 are no seasoning requirements to this rule
- As long as the payment agreement is in 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.
Do Not Pay Off Old Collection Accounts Without Negotiating With Creditor
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.
Agreed Payment on Written Payment Agreement with Credit Can be Used In Lieu of 5% of Outstanding Collection Balance For Debt to Income Ratio Calculations
Make sure whatever negotiated amount is in writing. If deciding to settle on a collection account on pennies on the dollar, make sure that part of the agreement is to have the collection agency delete derogatory collection items 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 items which will drop credit scores.
Retracting Credit Disputes Will Lower Credit Scores
Credit scores can drop as much as 100 points when it is re-activated with a new updated date of the last activity. Home Buyers who need to qualify for a 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 a 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.
UPDATED FHA Guidelines On Collection Accounts And Charge Offs
If consumers default on a credit card, auto loan, student loan, installment loan, or any other loan obligation and do not meet those payment obligations, those accounts will go into default, and collection activities will start. Most folks have the good intention of paying all of their monthly debt obligations. They have no intention of defaulting. There are circumstances where a consumer may lose their job or lose their business. The outcome is where their income stream comes to an abrupt halt. There are many consumers who can no longer meet their monthly debt obligations. When this occurs, the creditor will try to collect on the debt internally for 90 days.
Getting FHA Approval With Charged-Off Accounts
If a consumer does not make payment arrangements, then the creditor will most likely charge it off. Creditors normally sell bad debt to a third-party collection agency. The third-party collection agency will then purchase the debt for pennies on the dollar. Or the third party collection agency may contract with the creditor where they get a percentage on what they collect. In either case, collection activities will be aggressively pursued the first six to 12 months of a fresh collection debt.
Tactics Collection Agencies Use To Collect Debt
Tactics that collection agencies use are the following:
- calling consumers
- mailing consumers with threats like collection letters
- letters may have a law firm name on it and state if they do not contact the collection agency within the next few days, a lawsuit will be filed and wage garnishment proceedings can be initiated
Many times, consumers get frightened with such collection tactics:
- Often times borrow money from friends and family members and pay the collection agencies on their collection accounts
- Unfortunately, most consumers cannot continue to make the payments because they cannot find full-time employment
- They eventually give up paying the creditor
- With FHA Guidelines On Collection Accounts, collection and charged-off accounts do not have to be paid to qualify for a mortgage
FHA Guidelines On Collection Accounts And Process Of Collection Accounts
As stated earlier, most collection agencies aggressively pursue trying to collect a delinquent collection account when they first get it:
- After the collection accounts age, it is harder and harder to collect on collection accounts
- Most consumers stopped getting harassed after a year or two
- As the collection and charge off accounts age, most collection agencies give up on trying to collect
- Collection and charge off accounts get bought and sold all the time from collection agencies
As collection accounts, age, the less of a likelihood the collection agency will pursue the legal activity to get a judgment.
Why Are Lenders Concerned On Collection Accounts?
The biggest fear with collection accounts is that every collection account can turn into a judgment. A judgment is the worst credit derogatory item consumers can have. A judgment is a court’s decision that a debtor owes a judgment creditor money.
Courts give authorization to the judgment creditor to proceed with legal proceedings such as the following:
- attaching liens on assets
- garnishing bank accounts and wages
- to enforce the judgment creditors need to follow the legal process
Most collection agencies will not pursue legal proceedings to get a judgment on a debt unless they know or feel that the judgment debtor has assets or high income because legal proceedings can be quite costly. A judgment creditor that has a judgment on a consumer who is unemployed or has no assets cannot collect on the judgment. This because people like these are considered being judgment proof.
Being judgment proof means that the judgment debtor has no means of paying back the judgment issued by the courts.
Can I Qualify For Mortgage With Unpaid Collection Accounts?
FHA Guidelines On Collection Accounts allow for a home buyer or homeowner who needs a refinance mortgage to be eligible for an FHA loan with unpaid collection accounts:
FHA has two categories for collection accounts per FHA Guidelines On Collection Accounts:
- The first category is medical collections
- All medical collection accounts with unpaid balances are exempt and do not count
The second collection category that FHA has is non-medical collection accounts:
Unpaid non-medical collection accounts are the following:
- such as credit card accounts
- installment debt
- or other unpaid collection accounts
However, per FHA Guidelines On Collection Accounts if the unpaid non-medical collection accounts have balances of $2,000 or greater, then 5% of the unpaid balance will be used:
- This figure will be counted towards debt to income calculations as a hypothetical debt
Borrowers with a bunch of smaller unpaid collection accounts and the aggregate balance of the total of all of the aggregate unpaid balance yield an unpaid balance of $2,000 or more, the following will apply:
- 5% of the unpaid aggregate balance will be used towards calculating debt to income ratios
Charge offs and zero balance non-medical collection accounts do not count per FHA Guidelines On Collection Accounts.
What If Unpaid Collection Account Has Large Balance?
There are cases where unpaid collection accounts can have extremely high unpaid balances such as $10,000 or more.
- This is such the case on auto repossessions or higher ticket credit items
Let’s take a case scenario:
- collection account with an unpaid balance of $20,000
- 5% of the unpaid balance is $1,000 per month
- that $1,000 per month will be used towards debt to income calculations
The good news is that FHA allows you to make a written payment agreement with the collection agency:
- Whatever minimum monthly payment agreement is, that payment will be used towards debt to income calculations
On the above example:
- if a consumer were to make a written payment agreement with the collection agency of the $20,000 unpaid collection balance
- got a written executed payment agreement making $100 per month
- that $100 per month will be used to calculate the debt to income ratio
- this figure is used instead of the $1,000 monthly payment
- 5% of the $20,000 unpaid collection balance is no longer used to calculate the debt to income ratio
The good news is that this is effective immediately and no monthly payment seasoning is required.