Do I have to pay off collection accounts to qualify for an FHA home loan? That’s a question on the mind of anyone who has a collection agency action in their credit history. What does the FHA have to say about this issue?
On the FHA official site, there is a Frequently Asked Questions section that directly addresses this potential problem for loan applicants nervous about issues in their credit report. It begins with a definition of the phrase “collection account”:
“A Collection Account refers to a Borrower’s loan or debt that has been submitted to a collection agency by a creditor.”
FHA loan rules address collection accounts in the amount of $2000 or more:
“If the credit reports used in the analysis show cumulative outstanding collection account balances of $2,000 or greater, the lender must:
-verify that the debt is paid in full at the time of or prior to settlement using an acceptable source of funds;
-verify that the Borrower has made payment arrangements with the creditor and include the monthly payment in the Borrower’s Debt-to-Income ratio (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 Borrower’s DTI.”
Note that the lender is required to take action when the collection accounts are $2000 or more “cumulatively”. The total balance of the collection accounts will be an important factor.
Regardless of the outcome of the lender’s action on the above, FHA loan rules also require supporting documentation to justify approving the mortgage loan when there are collection accounts present in the applicant’s credit history. According to the FHA official site:
“The lender must document reasons for approving a mortgage when the Borrower has any collection accounts.”
That’s not all-the applicant will also be required to provide additional documentation. “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. ”
Speak to your loan officer to learn what lender standards may be in this area. You may find lender standards to be higher or more demanding than FHA loan program minimum requirements, and standards may vary depending on the lender.