Conventional Mortgage Guidelines for Collections & Charge offs

2018 FHA Guidelines for Collections & Charge Offs
May 25, 2018
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Conventional Mortgage Guidelines for Collections

Anyone can experience an accident in life that can disrupt their financial situation. Medical emergency, losing a job, bad investment etc. can all have negative impact on our financial situation. These kinds of events can even cause a bankruptcy or charge offs. When a creditor declares that the consumer cannot pay the amount of the debt, then this is called a charge off.

Normally, creditors wait for six months before making this declaration and if the consumer is not able to make payments for six months, the debts are charged off. A charge off does not mean that the consumer will not be required to pay the debts anymore. Soon after the debt has been charged off, the lender can sell it to a third party collection agency. The collection agency would try to collect on the bad debt. Collection agencies are ruthless and do everything in their power to get the consumer to pay the debt. A consumer owes his/her debt until it is settled, paid off or discharged by bankruptcy filing.

Most borrowers think that if they have outstanding charge offs and collection accounts, they cannot qualify for conventional loans. This misconception is the reason many home buyers don’t consider conventional loans and go with FHA loans. The truth is even with outstanding charge offs and collection accounts, home buyers can still qualify for a conventional loan.

However, the requirements of Freddie Mac and Fannie Mae are stringent and tougher than that of the United States Housing and Urban Development’s (HUD’s) for FHA loan. When it comes to outstanding charge offs and collection accounts, the tougher restrictions of Freddie Mac and Fannie Mae can make it hard for home buyers to qualify for a loan.

Each mortgage program has different guidelines when it comes to charge offs, late payments, judgments, tax liens and collection accounts. The FHA is preferred by borrowers because it has lenient guidelines on charge offs and collections.

FHA Guidelines for Charge offs and Collections

According to the updated FHA guidelines for charge offs and collections, home buyers don’t have to pay their outstanding charge offs and collection accounts in order to qualify for an FHA loan. Collection accounts are classified by the FHA into three different categories. These include non-medical collection accounts, medical collection accounts and charge offs. The FHA exempts charge off accounts and medical collection accounts from debt-to-income ratio (DIT) calculations. However, if the balance in non-medical collection accounts is more than $2,000, then the FHA stipulates that 5 percent of the outstanding collection accounts be used for calculating the debt-to-income ratio of the borrower.

Borrowers can qualify for an FHA loan with outstanding judgment and tax liens without paying them in full. However, written payment agreements with the creditor are required. In addition, the borrower needs to have paid payments of three months and he/she must provide canceled checks of three months or bank statements as a proof.

Requirements of the FHA are also lenient for those borrowers who filed bankruptcy. Borrowers who file Chapter 13 Bankruptcy can qualify for an FHA loan after one year of repayment plan provided that they made 12 timely payments during the period of this one year. However, if the borrowers have not made at least 12 timely payments, they won’t be able qualify for an FHA home loan.  Approval will be required from the Trustee for the FHA loan. In order to qualify for an FHA loan with Chapter 7 Bankruptcy, borrowers must wait for a period of two years.

Borrowers can qualify for an FHA home loan even with bad credit. But, timely payments in the past 12 months are mostly required for approval per Automated Underwriting System (AUS). The FHA realizes that borrowers can have bad credit periods, but it requires them to reestablish their credit by making timely payments before they can qualify for an FHA loan.

As you can see, the mortgage lending requirements of the FHA are quite lenient. That is why most borrowers who have bad credit, outstanding charge offs and collection accounts and unpaid judgment and tax liens choose an FHA loan over conventional loans. But, you should know that there is chance that you may qualify for conventional loans like Freddie Mac and Fannie Mae with outstanding collections and charge offs. I shall discuss the mortgage guidelines of conventional loans for collections and charge offs to help you determine whether you can qualify for conventional loans with outstanding charge offs and collections or not.

Fannie Mae Guidelines for Collections

According to the guidelines of Fannie Mae, on the credit report of consumer all credit accounts reported past due which aren’t reported as collections accounts need to be brought up-to-date and current for the borrowers in order to qualify for a home loan. If you are qualifying for owner occupant residential property (one unit), you are not required to pay off outstanding non-mortgage charge off accounts or collection accounts no matter what the balance of the collection account is.

If you want to purchase a second residential property or 2 to 4 unit owner occupant residential property, outstanding non-mortgage charge offs and collection accounts that are more than $5000 must be paid completely at closing or before it. If you wish to qualify for a conventional loan to purchase a property for investment and individual outstanding collections and non-mortgage charge off accounts are equal or greater than $250, you must pay them at closing or before it. If the collection accounts balance is more than $1,000, then you will have to pay them in full at closing or before it.

Loan Requirements for Collection Accounts

The mortgage lending guidelines of FHA does not require borrowers to pay off their outstanding collection accounts. FHA exempts medical collection accounts from debt-to-income ratio calculation and borrowers are not required to pay any of it in order to qualify for an FHA loan. However, with non-medical collections, for any balance of more than $2,000, mortgage lenders will use the 5 percent of the outstanding non-medical collection accounts balance in calculating debt-to-income ratio, but the borrower is not required to pay.

For example, if you have a total of $12,000 outstanding collection accounts balance, then 5 percent of the total unpaid $12,000 collection account balance or $600 will be used for calculating your debt-to-income ratio, but you don’t have to pay $600 per month. If your outstanding collection accounts balance is very large, HUD may allow you to make a written payment agreement with the creditor. That new written payment agreement can be used in place of the 5 percent.

If you the total balance in your collection accounts is $10,000 and you set up a written agreement with the collection agency or creditor for $250 per month, then the mortgage underwriters will use that $250 instead of the 5 percent of $10,000 for calculating debt-to-income ratios. The mortgage guidelines of the United States Housing and Urban Development (HUD) are generous towards home buyers who want to acquire a loan with tax liens, judgment, outstanding collections and charge off accounts and bad credit. The HUD allows loan borrowers with tax liens and judgment to get into a written agreement with judgment creditor.

Conventional Loan Lender Overlays and FHA Lender Overlays

Many borrowers fail to qualify for conventional loans from mortgage lenders or banks because of outstanding charge offs and collection accounts.

Most mortgage lenders and banks don’t approve mortgage borrowers with outstanding charge offs and collection accounts and tell the borrowers that they must pay outstanding charge offs and collections in full in order to qualify for conventional loans. Some mortgage lenders and banks have even more stringent requirements. They not only require mortgage borrowers to pay their outstanding collections and charge off accounts, but also wait for two years after the payment has been made. Why does this happen when conventional mortgage guidelines for collections and charge offs don’t put these conditions on borrowers?

The reason many mortgage lenders and banks require borrowers to pay off their outstanding collection and non-mortgage charge off accounts in full and have a waiting period before borrowers can qualify for a conventional loan is because of lender overlays. Conventional loan lender overlays are additional requirements for conventional loans that mortgage companies and banks set themselves. These guidelines are tougher than those given by Freddie Mac and Fannie Mae and make it hard for borrowers to qualify for a conventional loan. Mortgage lenders and banks are free to set tougher lender requirements than those given by Freddie Mac and Fannie Mae and there is no law that can stop them from doing so.

Lender overlay is a major issue for mortgage borrowers with outstanding collections and charge off accounts. It not only restricts them from qualifying for a conventional loan, but also makes it hard for borrowers to qualify for an FHA home loan.

FHA mortgage lenders set higher loan requirements on top of the FHA guidelines. These higher lender requirements for FHA loans by mortgage lending companies are classified as FHA lender overlays. For example, many mortgage lenders will tell you that in order to qualify for an FHA loan, your collection accounts must not exceed $5,000. According to the updated FHA guidelines for charge offs and collections, mortgage borrowers can qualify for an FHA home loan no matter how high the charge off account balance is. This means that the condition for the collection accounts balance not exceeding $5,000 is set by mortgage lenders themselves and is thus a FHA lender overlay.

In addition to this, FHA mortgage lenders also tell other things that are not included in the FHA guidelines. For example, they might tell you that if you have outstanding collections and charge offs, you cannot qualify for an FHA home loan. Or they might say that after the collection account has been paid in full, you must wait until the payment reflects on your credit report. These are all FHA lenders overlays and if a mortgage lender tells you these things, you should be aware that these are not FHA guidelines and the lender is imposing these additional guidelines on their own. Don’t work with such mortgage lenders who make it hard for you to acquire a mortgage; rather choose a mortgage lender who strictly follows FHA guidelines. You should choose a mortgage lender who tells you that you are not required to pay off your outstanding collections and charge off accounts in order to qualify for an FHA loan and you can qualify for the loan no matter how high your collection account balance is.

Freddie Mac and Fannie Mae Requirements for Collection Accounts

When it comes to unpaid charge offs and collections, judgment and tax liens, mortgage guidelines of conventional loans are very different than the guidelines for FHA or apartment building loans. All unpaid collections accounts and charge offs must be paid by the mortgage borrower at closing or before it for conventional loans while mortgage borrowers can qualify for an FHA loan without paying collections and charge off accounts. Similarly, if you have unpaid judgment and tax liens and you want to qualify for a conventional loan, you must pay them in full at closing or before it. If you have a balance of $250 or less in collection accounts or the total aggregate outstanding unpaid balance is $1,000 or less then it may be exempt depending upon the decision of the mortgage underwriter.

In a nutshell, if you have outstanding unpaid collection and charge off accounts, then you should consider an FHA home loan as FHA guidelines for collections and charge offs are more lenient. But, if you wish to go for conventional loan, you must fulfill all the stringent requirements.

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, #NMLS 227262. He is an expert not only in lending but multiple facets of real estate, particularly the title industry. Matt 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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