June 26, 2017

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Collection Accounts and FHA Loans

We’ve had some recent questions about home loans and collection accounts lately; in light of those questions it seemed like a good time to review the FHA loan rules on collection accounts as found in HUD 4000.1.

The FHA loan rule book has instructions for the lender on what to do when reviewing such credit report data and it never hurts to know what your loan officer’s marching orders are in this area-at least where FHA minimum standards are concerned.

The information below may be supplemented or affected by lender standards, so know that you’ll need to see what’s possible with a specific lender if any of the rules quoted here apply to your circumstances. Lender standards will definitely apply in addition to what’s found in HUD 4000.1.

Let’s begin with the FHA definition of a collection account-what is it? According to page 183 of HUD 4000.1, “A Collection Account refers to a Borrowers loan or debt that has been submitted to a collection agency by a creditor.”

If a lender finds collection account information on an FHA loan applicant’s credit history, the lender is required to review that information to see how much the collection is for.

“If the credit reports used in the TOTAL Mortgage Scorecard analysis show cumulative outstanding collection account balances of $2,000 or greater, the Mortgagee must:

-verify that the debt is paid in full at the time of or prior to settlement using acceptable sources of funds;
-verify that the Borrower has made payment arrangements with the creditor and include the monthly payment in the Borrowers DTI;

or

-if a payment arrangement is not available, calculate the monthly payment using 5 percent of the outstanding balance of each collection and include the monthly payment in the Borrowers DTI.”

“DTI” as used in the quotes above refers to “debt-to-income ratio” and as you can see, having a collection account on your record may not be an automatic barrier to getting an FHA mortgage, but certain standards will definitely apply.

One area not mentioned in the quotes above include community property issues-what about collection accounts for those who are married and living in community property states? How would the collection account of a non-borrowing spouse in a community property state affect the applicant’s chances? According to HUD 4000.1:

“Collection accounts of a non-borrowing spouse in a community property state must be included in the $2,000 cumulative balance and analyzed as part of the Borrowers ability to pay all collection accounts, unless excluded by state law.”

As you can see, it’s very important to have a conversation with your loan officer if you aren’t sure how a collection action might affect your home loan.

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