FHA Mortgages: Do Collections Need to Be Paid Off?
Collections on a credit report always have the potential to cause problems when applying for a FHA mortgage.
Technically, FHA does not require that collections be paid off as part of a mortgage approval but if the total balance of the collection accounts is $2000 or higher these collections will be factored into the borrower’s mortgage qualifying. FHA requires what they call a “Capacity Analysis” when the total balance reaches $2000 or higher.
Per the FHA Guidelines, a Capacity Analysis includes any of the following actions:
- At the time of or prior to closing, payment in full of the collection account (verification of acceptable source of funds required).
- The borrower makes payment arrangements with the creditor. If the borrower has entered into a payment arrangement with the creditor, a credit report or letter from the creditor verifying the monthly payment is required. The monthly payment must be included in the borrower’s debt-to-income ratio.
- If evidence of a payment arrangement is not available, the lender must calculate the monthly payment using 5% of the outstanding balance of each collection, and include the monthly payment in the borrower’s debt-to-income ratio.
Essentially, the FHA is dictating that if a borrower has a $2000 or higher total collection balance, a payment will be assigned to this balance. For example, if a borrower has $5000 in total collection balances, the underwriter will assign a $250 payment (5% of the balance) to the borrower’s monthly debt. This assigned payment will need to fit into the borrower’s debt to income ratio. The borrower can also make arrangements with the creditor directly to avoid this assigned 5% payment. This arranged payment would then be used instead of the 5% payment. Of course, the other option would be to pay the collection off and provide evidence of this final payment.
When applying for an FHA Mortgage, collections may or may not make the difference between loan approval and loan denial.
The FHA differentiates between Medical Collections and Non-Medical Collections.
Just like Non-Medical collections, Medical collections do not need to be paid off. However, unlike Non-Medical collections, Medical collections are not required to be factored into the above Capacity Analysis. Any old collections that have reached “Charge Off” status are also not factored into the Capacity Analysis.
When applying for an FHA Mortgage, collections may or may not make the difference between loan approval and loan denial. In addition to possibly factoring into the debt ratio, any collection (medical/non-medical) will factor into your credit score. If you do have collections on your credit report, it is strongly advised that these be reviewed before select a home or apply for a mortgage. The accounts can make the difference in your potential FHA Mortgage approval.