A recent reader question asked, “I have an outstanding judgment in the amount of $8000. Can I still get a loan?”
FHA loan rules are clear on the issue of credit, stating that past credit performance and patterns are considered one of the best indicators of whether an FHA loan application should be approved. But recently, the FHA has issued clarifications and updates to lenders on the subject of judgments, collections and other activities that could be considered negative credit data.
According to FHA Mortgagee Letter 2013-24, Handling of Collections and Disputed Accounts, the FHA has amended its guidelines and policies for collections, disputed accounts, and judgments for most credit-qualifying FHA loan transactions. It applies to all affected FHA loans with case numbers assigned on or after October 15, 2013.
According to the mortgagee letter, “Collections and judgments may indicate a borrower’s disregard for credit obligations and must be considered in the creditworthiness analysis. The guidance below applies to loans with collection accounts and all judgments. Medical collections and charge off accounts are excluded from this guidance.
Documentation Requirements: Collection Accounts and Judgments Applicable to Manually Underwritten Loans:
The lender must document reasons for approving a mortgage when the borrower has collection accounts or judgments.
Regardless of the amount of outstanding collection accounts or judgments, the lender must determine if the collection account or judgment was a result of:
- the borrower’s disregard for financial obligations;
- the borrower’s inability to manage debt; or
- extenuating circumstances.
The borrower must provide a letter of explanation with supporting documentation for each outstanding collection account and judgment. The explanation and supporting documentation must be consistent with other credit information in the file.
Applicable to Loans Run Through TOTAL Mortgage Scorecard:
TOTAL Mortgage Scorecard Accept/Approve – There are no documentation or letter of explanation requirements for loans with collection accounts or judgments run through TOTAL Mortgage Scorecard receiving an “Accept/Approve” despite the presence of collection accounts or judgments. These accounts have been already taken into consideration in the borrower’s credit score. If TOTAL Mortgage Scorecard generates a “Refer,” the lender must manually underwrite the loan in accordance with the guidance above applicable to manually underwritten loans with collection accounts and judgments.”
As you can see, FHA loan rules take judgments, delinquencies and other negative credit information very seriously. However, there is some lattitude given when it comes to paying off collections. According to the mortgagee letter, “FHA does not require collection accounts to be paid off as a condition of mortgage approval. However, FHA does recognize that collection efforts by the creditor for unpaid collections could affect the borrower’s ability to repay the mortgage.”
“To mitigate this risk, FHA is requiring a capacity analysis of collection accounts with an aggregate balance equal to or greater than $2,000…If the total outstanding balance of all collection accounts for all borrowers is equal to or greater than $2,000, the lender must perform a capacity analysis as detailed below. Unless excluded under state law, collection accounts of a non-purchasing spouse in a community property state are included in the cumulative balance.”
Do you have questions about FHA loan rules? Ask us in the comments section.