Can I get an FHA home loan approved even if I have a debt collection in my credit history? That is an important question on the minds of some FHA loan applicants going into the home loan process.
This type of credit issue is commonly referred to as having a collection account, which HUD 4000.1 (the FHA Loan Handbook) defines as follows:
“A Collection Account refers to a Borrower’s loan or debt that has been submitted to a collection agency by a creditor.”
Collection accounts can be an issue for an FHA loan applicant; generally it is strongly recommended to come to the application process with 12 months of on-time payments for all financial obligations.
Depending on circumstances (such as when the lender is required to manually underwrite the loan), the lender may be required to verify collection accounts as ordered in HUD 4000.1, which states:
“If the credit reports used in the 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 an acceptable source of funds;
-verify that the Borrower has made payment arrangements with the creditor; 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 Debt-To-Income ratio.”
Note that FHA home loan rules do not automatically deny a loan to a borrower with these issues; that said, lender requirements will also apply so borrowers should check with the loan officer to see what other rules may apply in these cases.
Some borrowers come to the FHA mortgage process without collection accounts of their own, but are worried about whether a spouse’s credit problems may be an issue for the home loan or refinance loan. Community property laws, where applicable, may be a factor.
HUD 4000.1 says in these cases:
“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 Borrower’s ability to pay all collection accounts, unless specifically excluded by state law.”
Your participating FHA lender will require some documentation in these cases. This may include any evidence of payment in full (if paid prior to settlement), the official payoff statement, or evidence of a satisfactory payment arrangement with the creditor.
HUD 4000.1 adds, “If the Mortgagee uses 5 percent of the outstanding balance, no documentation is required.” Additional lender standards may apply above and beyond these FHA loan minimum requirements.