FHA Mortgage Guidelines On Collection Accounts And Charge Offs

Updated FHA Mortgage Guidelines On Collection Accounts And Charge Offs

This BLOG On FHA Mortgage Guidelines On Collection Accounts And Charge Offs Was UPDATED On September 6h, 2018

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. 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 FHA does not require it. This is because many lenders have mortgage overlays. The Gustan Cho Team at Loan Cabin Inc. has no mortgage overlays on FHA, VA, USDA, and Conventional Loans.

What Are Lender Overlays?

  • 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 FHA mortgage guidelines on collection accounts
  • For example, to qualify for a residential mortgage loan via a FHA insured mortgage loan, the minimum credit score required is 580
  • However, many banks, credit unions, and mortgage bankers may have their own lender overlays where they will set their own minimum credit score requirements
    • Examples of overlays on credit scores is requiring a minimum credit score of 640 when FHA minimum requirements 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 and not FHA Guidelines

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 mortgage loan 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 
  • The Gustan Cho Team at Loan Cabin Inc. has zero overlays
  • As long as borrowers meet the minimum and get an approve/eligible per Automated Underwriting System, we just go off AUS with no other overlays

2018 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, 2018 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 for FHA Home Loans

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 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 2018 FHA guidelines on collection accounts and prior to recently, the unpaid collections balance did not matter
  • Those with many unpaid collection accounts can be affected by the new 2018 FHA guidelines on collection accounts

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 2018 FHA 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 require on medical collections
  • Medical collections will not affect borrowers debt to income ratios

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

  • New 2018 FHA guidelines concerning credit disputes require that borrowers cannot have any non-medical credit disputes on any derogatory credit item that is larger than $1,000
  • Mortgage Process will be halted if borrowers have any disputes with any credit reporting agency on derogatory credit items with a credit balance above $1,000
  • 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
  • Borrowers can dispute negative derogatory credit items with zero balances as well as medical collections

What If  I Have Large Collections And The 5% Rule Will Yield A High Debt To Income Ratio?

Borrowers with substantial unpaid collection accounts, FHA guidelines on collection accounts can pose a problem.

  • Remember that lenders will now require that 5% of the unpaid 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, FHA will 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 borrower has set up a 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 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 rule does not apply.  Borrowers can dispute a derogatory medical collection credit item with a balance and are exempt from the dispute rules and regulation.

Do Not Pay Off Old Collection Accounts Without Negotiating

Borrowers deciding to pay off an old outstanding collection account, do not pay them a cent until they can get a pay for delete agreement with the collection agency.

  • 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
  • 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

Home Buyers who need to qualify for mortgage with a direct lender with no mortgage overlays can contact us at The Gustan Cho Team at Loan Cabin Inc. at 262-716-8151 or text us for faster response. Or email us at gcho@gustancho.com. We have no overlays on FHA, VA, USDA, and Conventional Loans. We are available 7 days a week, evenings, weekends, and holidays.

Gustan Cho

www.gustancho.com

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