We’ve gotten several questions in the comments section about certain credit issues related to charge-offs, collections and other forms of derogatory credit information. With those questions in mind it seems like a good time to review the rules as published in HUD 4000.1 that instruct the lender on how to interpret these things and decide on loan approval.
But before we start looking at the rules, it’s very important to point out that the information listed here are FHA minimum standards. A given lender or financial institution may have more strict requirements depending on circumstances, state laws, or other factors. Remember that FHA loan rules don’t override state law and lenders are free to require higher standards as long as they are in compliance with federal laws.
When it comes to collections on a borrower’s credit report, FHA loan rules in HUD 4000.1 instruct the lender:
“A Collection Account is a Borrowers loan or debt that has been submitted to a collection agency through a creditor. The Mortgagee must determine if collection accounts were a result of:
–the Borrowers disregard for financial obligations;
–the Borrowers inability to manage debt; or
The Mortgagee must document reasons for approving a Mortgage when the Borrower has any collection accounts. The Borrower must provide a letter of explanation, which is supported by documentation, for each outstanding collection account. The explanation and supporting documentation must be consistent with other credit information in the file.”
As you can see, sometimes the mere presence of derogatory credit information isn’t enough to stop an FHA mortgage loan if the lender can determine an acceptable reason for that information appearing on the report–acceptable as in, the borrower is still a good credit risk.
When it comes to charge-off accounts, FHA loan rules are similar. Some borrowers may not be familiar with the phrase “charge-off”. How does the FHA loan rule book define this? According to HUD 4000.1, “Charge Off Account refers to a Borrowers loan or debt that has been written off by the creditor.”
Similar to collection actions, the lender is required to determine if Charge Off Accounts were a result of “the Borrowers disregard for financial obligations, the Borrowers inability to manage debt; or extenuating circumstances.”
Furthermore, the lender is require to “document reasons for approving a Mortgage when the Borrower has any Charge Off Accounts. The Borrower must provide a letter of explanation, which is supported by documentation, for each outstanding Charge Off Account. The explanation and supporting documentation must be consistent with other credit information in the file.”
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