2018 VA Guidelines for Collections & Charge Offs

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Often times, buyers experience a period where their income drops: they can’t find a job to pay for their expenses, suffer from a medical emergency or fall victim to any other adverse event. These kinds of periods can cause different credit issues like charge offs. The declaration by a creditor that debt is unlikely to be collected is called a charge off. A charge off can have a certain balance remaining or it can just be shown as a charge off of zero balance. This is a major issue and often home buyers will find it hard to acquire a home loan if they get a charge off.

However, if you are a veteran, you don’t have to worry about the issue of charge off and collections. Being a veteran doesn’t only give you the pride of serving the nation, but it also brings several benefits from the government. One such benefit is the VA loan. The U.S. Department of Veterans Affairs (VA) insures the VA loan that is offered by many mortgage lenders across the United States. The reason for creating VA loan was to help veterans buy a home without a down payment even when their credit score is low. The loan is not directly offered by the VA, the loan is just insured by it in case the borrower defaults on it. There are several benefits of VA loans like no down payment, no mortgage insurance, higher debt-to-income ratios are accepted, low interest rates, low costs of closing and easier qualification requirements than traditional loans. Another major benefit that we are going to discuss in this post is that the VA loan allows veterans to get a mortgage for a new home even with outstanding charge offs and collection accounts.

VA Guidelines for Collections and Charge Offs

As per the updated VA guidelines for collections and charge offs, veteran borrowers who want to acquire a loan can qualify for a VA loan with outstanding collection accounts and charge offs. The VA guidelines for collections and charge offs stipulate that veteran borrowers can qualify for a VA home loan without paying outstanding charge offs and collection accounts. However, not all VA mortgage lenders follow the guidelines of the U.S. Department of Veterans Affairs. Most VA mortgage lenders have lender overlays that make it hard for veteran borrowers to qualify for the VA loan.

What are VA Lender Overlays?

In the United States of America, one major issue that often restricts buyers from qualifying for a home loan is lender overlays. Some mortgage lenders don’t approve VA home loan even when the veteran borrowers meet the guidelines set by VA. Mortgage lenders set higher requirements for a VA home loan that are above and beyond those declared by the VA. The additional requirements that VA mortgage lenders set on their own are called VA lender overlays. Most veteran borrowers fail to qualify for a VA home loan from mortgage lenders mainly because of VA mortgage lender overlays.

You should know that just because you are not able to qualify for a VA loan from one lender doesn’t mean that other lenders will reject your application for the loan too. There are some lenders who strictly follow the guidelines set by the U.S. Department of Veterans Affairs and don’t have any kind of lender overlays, so you’ll have more chance of qualifying for a VA loan if you take your case to these lenders.

Typical VA Lender Overlays

Typically most lenders set overlays on the credit score requirements. As highlighted earlier, for VA home loans minimum credit score requirement is not included in the guidelines set by VA, but most lenders ask for a credit score of 620 or more from veteran borrowers. This credit score requirement makes it hard for veteran borrowers to qualify for a home loan. I recommend that veteran borrowers should at least have a credit score of 580 in order to be eligible for VA loan per Automated Underwriting System (AUS) Findings.

Lenders who follow the guidelines of the U.S. Department for Veteran Affairs (VA) don’t have a requirement for a minimum credit score or any other overlays which make it easy for veteran borrowers to qualify for a VA loan.

Most VA mortgage lenders require a debt-to-income ratio of 41 percent to 50 percent. This is not a VA requirement and the U.S. Department of Veteran Affairs doesn’t specify any debt-to-income ratio requirement. At Loan Consultants, we don’t have debt-to-income ratio requirement to ensure that veteran borrowers can easily qualify for a VA home loan.

Most VA mortgage lenders tell veteran borrowers that they cannot qualify for a VA home loan unless they pay off their outstanding charge offs and collection accounts. This is another VA lender overlay and goes against the guidelines set by the U.S. Department of Veteran Affairs. The VA guidelines for collections and charge offs have clearly stated that veteran borrowers can qualify for VA home loan with outstanding collections and charge offs if they meet the Automated Underwriting System approval.

How Outstanding Collections Can Be Paid

Some lenders require borrowers to pay off their outstanding collection accounts in order to qualify for a VA home loan, but paying off outstanding collection accounts can drop credit scores. The reason is that when outstanding collection accounts are paid off, the last activity date is reset. Many veteran buyers hire credit repair agencies that charge high amounts to delete older charge offs and collection accounts that mostly don’t have an impact on the credit scores.

Sometimes credit scores drop by 50 or even more when open collections accounts are paid off by people. Consumers who wish to satisfy an old outstanding collection account should always contact the creditor before fixing it. They should work out an agreement where the creditor or collection agency agrees to delete off the derogatory item from the credit report in return for the consumer’s payments on outstanding collections. Many creditors and collection agencies agree on this condition and delete the derogatory item from the credit report, but some don’t. Basically, what I mean to say is that the collection agency or the creditor should be told that they will be paid on one condition and one condition only and that is if they remove off the derogatory item from the credit report in return for payments.

Understanding the Charge Off and Collection Process

People who experience financial difficulties or lose their job may not be capable of paying minimum payment of debt. If their financial situation doesn’t improve and becomes worse, the creditor may contact them and demand they start paying the debts and catch up. The creditor will wait for a few months to see if the financial situation of the consumer improves or not. After four or six months, if the creditor doesn’t get paid, he/she will declare the debt as not collectable and may charge the debt off as bad debt. After the creditor has charged off the debt, he/she may sell it to a third party collection agency. The creditor can also take the case to the court and sue the consumer. The creditor will also report consumer to major credit reporting agencies.

How VA Guidelines for Collections and Charge Offs Affect Credit

The charge offs and collections accounts have a serious negative effect on credit scores. When consumers are not able to pay off their debts, the creditor won’t wait for their financial situation to improve. The creditor needs the payments on time and he/she cannot wait for too long. This is why if the consumer is not able to pay debts for four to six months, the creditor declares the debt as not collectible and hires a third party collection agency. The debts can be sold by creditors or they can work out a contract with the third party collection agency where they are to receive a certain percentage of the bad debt.

Collection agencies are aggressive and ruthless; they do everything they’re allowed to do in order to collect on the bad debt. The only way the collection agencies get paid is through collection of bad debt; this is the reason they are so aggressive. It’s simple, if they fail to collect, they won’t get paid. However, just because third party collection agencies are aggressive and ruthless and must collect the bad debt doesn’t mean they’re to do anything. Third party collection agencies are regulated by Federal rules and they must follow these rules when collection debts.

Unfortunately, most collection agencies don’t follow the Federal rules. Many times third party collection agencies turn to scare tactics in order to collect bad debts. If the efforts of the collection agencies aren’t successful and they are not able to collect bad debts, the debts will be written off by the creditor and it will be charged off. On the credit report of the consumer, the bad debt is reported as a charge off. It should be noted that just because the creditor has charged off the debt, doesn’t mean that collection agencies will leave the consumer in peace. They may still purchase charged off debts and try collecting on that debt. The charge off also doesn’t clear consumers from their past obligations of debt.

Collection Accounts

Veteran borrowers can qualify for a VA loan with charge off accounts under the updated guidelines of VA for collections and charge offs. However, there are different requirements for collection accounts. If collection accounts are reported on the credit report of the veteran home borrowers and the total outstanding balance of the non-medical collections is more than $2000, mortgage lenders are required to take 5 percent of the outstanding collection that will be used as a monthly debt.

For example, if you are a veteran borrower and have a collection accounts balance of $12,000, you are not required to pay off this $12,000 in order to qualify for a VA home loan. However, this $12,000 balance will increase your debt-to-income ratio. VA mortgage lenders will use 5 percent of the $12,000 or $600 as a monthly hypothetical debt. This debt of $600 will be added towards monthly obligations of payment, thus the debt-to-income ratio will increase. The reason for these requirements is that collection accounts could turn into judgment.

You Can Qualify for A VA Loan with Outstanding Charge Offs and Collections

The U.S. Department of Veteran Affairs (VA) has ensured that the veteran borrowers who experience financial hardships don’t experience problems in getting a home loan. VA has insured the VA home loan and declared guidelines on this loan that make it easy for veteran home buyers to qualify for a mortgage. Where other types of loans make it hard for borrowers to qualify for a mortgage with bad credit or outstanding charge offs and collections, the VA loan provides veteran borrowers an easy route as they can qualify for a VA home loan with outstanding collections and charge offs.

Borrowers are not required by the VA to pay off their open collection accounts. However, the veteran borrowers must work with VA mortgage lenders that do not have lender overlays on the VA loan. If a VA mortgage lender has lender overlays, the veteran borrower will find it very hard to qualify for a home loan and the lender will state requirements that are above and beyond those stipulated by the U.S. Department of Veteran Affairs. Neither Fannie Mag nor FHA or VA guidelines state that borrowers must pay off their collection accounts in order to qualify for a home loan.

If you have been denied a home loan or have any questions about real estate or mortgage please contact the author, Matt Herbolich, MBA, JD, LLM by phone or text at 786.390.9499 or by email at mherbolich@usa-mortgage.com. Mr Herbolich works when you work, so feel free to contact him any time.

Matthew Herbolich
Matthew Herbolich
Mr. Herbolich is a Senior Loan Officer at USA Mortgage, a division of DAS Acquisition Company, LLC NMLS 227262. He is an expert not only in lending but multiple facets of real estate, particularly the title industry. Matt Herbolich trains his fellow loan officers on title industry topics, real estate investing, and countless mortgage guidelines. Have any questions? Call at 888-900-1020 or send email to: mherbolich@usa-mortgage.com

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