This BLOG On Lender Overlays On Collection Accounts And Charged-Off AccountsWas UPDATED And PUBLISHED On November 14th, 2019
Home Buyers who have been turned down for a mortgage loan by a bank, credit union, or mortgage banker because due to having older collection accounts with balances may qualify for a mortgage but not with that particular lender.
- Just because borrowers have been turned down by one lender because of old collection accounts does not mean they do not qualify for a home loan with a different mortgage lender
- Many lenders have lender overlays on collection accounts and charge offs
- For example, there are many lenders who do not accept any collection accounts that have not been satisfied
- Borrowers do not have to pay outstanding collections and charged-off accounts to qualify for government and/or conventional loans
- These lenders want collection accounts fully paid and recorded as paid on all three credit reporting agencies but is not due to federal guidelines but because they have lender overlays
- Other lenders will not even consider borrowers if they had any collection account activities or delinquencies in the past two years, especially banks
In this article, we will discuss Mortgage Lender Overlays On Collection Accounts.
What Are Lender Overlays?
Mortgage lender overlays are a lender’s own guidelines on top of the minimum mortgage guidelines implemented by HUD, VA, USDA, Freddie Mac, and Fannie Mae
- For example, to qualify for a 3.5% down payment purchase home loan, FHA requires minimum of a 580 credit score
- However, most banks and credit unions will require minimum credit scores between 620 to 640
FHA requires maximum debt to income ratios up to 56.9% if credit scores are 620 or higher.
Common Overlays By Mortgage Lenders
However, many banks and credit unions may require the following:
- 640 credit score to cap debt to income ratios at 45%
- have a credit score of 680 or higher to have a debt to income ratio cap of 55%
- not even honor a 56.9% debt to income ratio cap altogether as part of their lender overlays
- Lender overlays can be placed on collection accounts and charged-off accounts
- A lot of mortgage lenders will not even look at borrowers unless they have paid off all of their collection accounts
- This is the case no matter how old the collection and charged-off accounts are
The good news is borrowers can qualify for a mortgage loan even with the outstanding unsatisfied collection and charge off accounts accounts.
Lending Guidelines On Collection And Charged Off Accounts
Borrowers with multiple unsatisfied collection accounts and charge off, FHA has a more generous policy in force than VA, USDA, Fannie/Freddie.
- FHA mortgage guidelines do not require borrowers to pay off the older collection and charged-off accounts to qualify for FHA Loans
- FHA guidelines on collection accounts have recently changed earlier this year
FHA differentiates collection accounts into two categories:
- Medical collection accounts
- Non-medical collection accounts
How Lenders View Medical Collections
All medical collection accounts are exempt under FHA collection account guidelines:
- Borrowers need not worry about it
- However, a lender may have borrowers pay off medical collection accounts as part of their lender overlays
- If a particular lender asks borrowers to pay off medical collection accounts with balances, then go somewhere
- This is because there are many lenders that do not have lender overlays on collection accounts and charge offs
The second type of collection accounts is non-medical collection accounts.
Examples Of Non-Medical Versus Medical Collections
Non-medical collection accounts are everything that is non-medical such as the following:
- credit card accounts
- auto repossessions
- cell phone bills
- installment loans
Any other creditor consumers have not paid and have reported on the three major credit bureaus.
Agency Guidelines On Debt To Income Ratios On Non-Medical Collections Versus Lender Overlays
Effective earlier this year, any non-medical collection accounts with a credit unpaid balance of $2,000 or greater, the mortgage underwriter will take 5% of the unpaid balance to calculate debt to income ratio
For example, here is a case scenario:
- if a consumer has an unpaid collection account with Capital One credit card from two years ago
- Outstanding balance is $2,000
- the mortgage underwriter will take 5% of the $2,000 unpaid balance, or $100 dollars, as part of monthly minimum debt obligations to calculate debt to income ratios
- This is the case even though the consumer will not be paying anything
Again, this is for only non-medical collection accounts only.
What If My Unpaid Collection Balance Is High?
There are cases where a collection account balance can be extremely high. This will throw off the applicant’s debt to income ratios. For example, in a recent case scenario, a borrower had an open collection balance of $20,000. 5% of $20,000 is $1,000 per month. This $1,000 per month will be used by the mortgage underwriter to calculate the borrower’s debt to income ratios. This is the case even though the borrower is not required to pay the $1,000 per month. There is a solution to this. FHA will allow the borrower to make a written payment agreement with the creditor on a set of the monthly payment. There is no payment seasoning requirement. On the above case scenario, if the borrower were to set up a written payment agreement with the creditor than he or she owes $20,000 to for $100 per month, that $100 per month will be used to calculate the borrower’s debt to income ratios in lieu of the $1,000 per month.