FHA loan rules have a lot to say about what the lender needs to look for to verify a potential FHA borrower’s creditworthiness.
No matter if you are looking for a condo loan, a mobile home loan, or you want to build a house on your own land with an FHA construction loan, the requirements in the FHA Lender’s Handbook are identical.
There are minimum FICO score requirements, instructions to the lender for reviewing the borrower’s record on-time payments (12 months of reliable payments on all financial obligations is strongly recommended), and much more.
One area that is also covered in HUD 4000.1 is what the lender should do if collections are included in borrower’s credit history.
The presence of a collection action on a loan applicant’s record may be cause for concern, but there are instructions to the lender on how to view collection accounts and what to do if those collections fall within the lender’s “tolerance” for loan approval.
What will the lender require under FHA loan rules if the loan can move forward?
HUD 4000.1 page 183 begins by defining what it views as a “collections account”:
“A Collection Account refers to a Borrowers loan or debt that has been submitted to a collection agency by a creditor.” In cases where such an account is present the lender is instructed as follows:
“If the credit reports used in the TOTAL Mortgage Scorecard 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 acceptable sources of funds;
- Verify that the Borrower has made payment arrangements with the creditor and include the monthly payment in the Borrowers Debt To Income (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 Borrowers DTI.”
There are also rules for the lender about collection accounts on a non-borrowing spouse’s record in “community property” states where state law may have a say in how a legally married couple’s joint debts are viewed or handled in the eyes of the law:
“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 excluded by state law.”
In cases where collections accounts are present, the lender is required to provide the following documentation:
- Evidence of payment in full, if paid prior to settlement;
- The payoff statement, if paid at settlement; or
- The payment arrangement with creditor, if not paid prior to or at settlement.
If your lender uses five percent of the outstanding balance, no documentation is required according to HUD 4000.1.
If you aren’t sure how these rules may apply in your situation, discuss your needs or concerns with a loan officer to see what that financial institution may require in such cases.