Many borrowers want to know if they are still eligible for a home loan even if they have debts that were referred to a collection agency. Can a borrower still get an FHA mortgage if they have collection accounts listed on their credit report?
The FHA rules governing this issue can be found in HUD 4000.1, which begins with the FHA definition of “Collection Accounts”:
“A Collection Account is a Borrower’s loan or debt that has been submitted to a collection agency through a creditor. “
When the lender finds collection information listed on the credit report, it is not necessarily an automatic denial of the loan waiting to happen. FHA loan rules require the lender to review the information to make sure the borrower wasn’t simply disregarding the debt owed. HUD 4000.1 instructs the lender that she “must determine if collection accounts were a result of:
- the Borrower’s disregard for financial obligations;
- the Borrower’s inability to manage debt; or
- extenuating circumstances. “
In these cases, the lender is required to obtain written explanations from the borrower as to the nature of the collection account. “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 from the above, the collection account itself does not result not an instant “no” from the lender, but take heed to what HUD 4000.1 says at the end of the section about collection accounts:
“The Mortgagee must document reasons for approving a Mortgage when the Borrower has any collection accounts. “
What can a borrower take away from that last line? That collection accounts, while not an automatic deal-breaker for a first-time home buyer or experienced house hunter, does make it more difficult for your lender to justify loan approval.
It may be a very good idea to put more time between the collection activity and your home loan application-especially if you need to establish a solid 12 months of 100% on-time payments on your FHA home loan.
Improving your credit takes time, and you should expect to spend a year following certain negative credit reporting events to get your credit and payment history back on track. Taking the extra time to do this will pay off.
If you need help understanding how your credit will affect your ability to get a home loan, you can always request a referral to a HUD-approved housing counselor. Call the FHA at their toll-free number 1-800-CALL FHA to request such a referral. You will be very glad you did.