A collection results from a borrower’s nonpayment of debt and that debt is submitted by the creditor to a collection agency. It is not uncommon for buyers to have collections reporting on their credit report. Collections can not only vary in size, but also in type. For instance, collections may result from medical bills, car repossessions, foreclosures, student loans, child support, and more, but just because there is a collection on the credit report, it doesn’t mean that it is an automatic denial. FHA collection guidelines provide options for many buyers to achieve home ownership with less than perfect credit.
Does FHA Require Collections To Be Paid Off?
The answer to the question depends on the scenario. When it comes to credit, it is almost like a snowflake. No one is quite like the other. Therefore, sometimes collections must be paid off, and sometimes collections may be left alone. So, let’s discuss the most common ways that FHA collection guidelines apply to:
- Collections totaling $2,000 or less
- Medical collections
- Collections in payment plans
- Collections being paid off at closing
- Including collections in debt to income ratio
- FHA Collection Guidelines Under $2,000
- First of all, debts in this category only include non-medical collections. Which means collections for repossessions, credit cards, or other loans. Non-medical collections totaling under $2,000 typically do not have to be paid off for FHA loan approval. It is important to note that it is a cumulative total of all collections that do not state “medical” on the report.
Does FHA Require Medical Collections To Be Paid Off?
Medical collections are the most popular collection types reporting on credit reports. Plus, many borrowers are not even aware of some medical collections. Therefore, it is easy to see how unknown collections pop up because of the confusion of medical bills being drug out by insurance claims.
Luckily, medical collections are excluded from the FHA $2,000 collection calculation. Although, medical collections still affect credit scores which can affect FHA loan approval. Typically, medical collections may stay open through an FHA loan closing.
FHA Collection Guidelines Payment Plan Option
Lenders have another option of verifying an existing payment plan for collection accounts. Rather than requiring the collection be paid off, an existing payment plan could be included in the borrower’s debt to income ratio. If a payment plan is in place, the terms plus the payment history must be documented.
Collections May Be Paid Off At Closing
What if my collection balances exceed $2,000? If the non-medical collections exceed $2,000, the borrower could pay off the collections. Do keep in mind that often it is best to pay off the collections at closing. The reason is that paying off a collection could actually lower a credit score in the short term. This is especially true when the date of last collection activity is not recently. Paying off collections that are not deleted from the reports could act like recent collection activity. The result is possibly a much lower credit score. If the current credit report expires and needs re-pulling prior to closing, this could be detrimental to a loan approval. Thus, paying collections at closing are often the better option.
FHA Collection Guidelines 5% of Balance Payment Option
What if my collections are over $2000, are not medical, not in a payment plan, and I can’t pay them off? There is another option! Rather than paying off the collections, a lender may calculate 5% of the collection outstanding balance for a payment. Let’s use a $10,000 collections as an example. A 5% calculated payment is $500. Therefore, the collection does not have to be paid off if the borrower qualifies with this payment.
FHA Delinquent Federal Debt Requirements
Now, if the borrower has delinquent federal debt reporting as a public record, credit report, or Credit Alert Verification Reporting System (CAIVRS), the lender must verify the status of the debt. If the debt is confirmed and currently delinquent, the borrower is ineligible for FHA financing. Examples of these debts include federal student loans and FHA insured mortgages, but there could be others.
No matter which option may be used for an FHA home loan, it is always essential to have a good, signed explanation letter from the borrower. The letter should provide the circumstances causing the collection and supporting documentation if possible. Other compensating factors are helpful as well. These could include solid rent payment history, using own funds as down payment, time on the job, extra monetary assets in reserves, and others.
Have questions? Call an OVM Financial loan officer now!