A collection occurs when a borrower does not pay a debt, and the creditor submits the debt 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 type. For instance, collections may result from medical bills, car repossessions, foreclosures, student loans, child support, and more. Still, 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 homeownership with less than perfect credit.
Does FHA Require You To Pay Off Collections?
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
- Collection pay 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 You To Pay Off Medical Collections?
A medical collection is the most common type of collection that appears on a credit report. 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. But 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. A borrower’s debt to income ratio can include an existing payment plan rather than requiring a pay off of the collection. If a payment plan is in place, we must document the terms and payment history.
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. If you pay a collection before closing can, it can lower your credit score in the short term. This is especially true when the date of the last collection activity is not recent. 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 before closing, this could be detrimental to loan approval. Thus, paying collections at closing is 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 payment. Let’s use a $10,000 collection 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.
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