FHA loans are one of three so-called “government-backed” mortgage loan programs. They’re sometimes referred to as government-backed not because the government approves the loan or is directly involved in any way but carries a guarantee to the lender should the loan ever go into default. This guarantee is financed by two separate forms of mortgage insurance, an upfront fee that is rolled into the loan amount and an annual premium paid in monthly installments and included with the monthly mortgage payment. This guarantee can allow lenders to approve FHA loans with a bit more leniency as it relates to credit and other factors. As long as the lender approved the FHA application using standard FHA guidelines, the guarantee stands.
Yet while FHA loans can be a bit more lenient that doesn’t automatically mean someone with damaged credit is guaranteed a loan approval. Lenders must still make the determination the mortgage will be paid back over time under the terms of the note. But bad things do happen over time and what was once a good credit history can be marred by bad marks, typically due to the result of circumstances beyond the borrower’s control. Such marks will cause credit scores to fall.
When a payment is made more than 30 days past the due date, scores will falter. If the same payment is made more than 60 days past the due date, scores will fall even further and will continue to do so if a payment is made more than 90 days past the original due date. Depending upon the policies of the creditor, the creditor at some point can freeze the account and send the account to its collections department. When a file goes into collections, this is an official designation credit reporting companies acknowledge and will continue to drive scores lower. Over time, if collection efforts are not successful and the lender decides the loan will never be paid back, the credit can simply “charge off” the account as uncollectable. This status will also appear on the credit report. And, you guessed it, scores will continue to drop. But that’s not necessarily the end of the mortgage world for FHA applicants. There are options. Here is how FHA guidelines treat collections and charged off accounts.
First, note that FHA guidelines do not require unpaid collection accounts to be paid off. Note, the lender might require some attention to unpaid collection accounts and supersede FHA guidelines. When a lender places its own internal requirements on an existing FHA guideline, the new requirement is referred to as an “overlay.”
There are three classifications FHA guidelines apply as it relates to the status of collection accounts. They are Medical accounts, Non-Medical accounts and collection accounts that have been charged off. Let’s take a closer look.
For Medical collection accounts, the account is essentially ignored and considered inconsequential to a mortgage approval. Why? Medical collection accounts are notoriously incorrect and confusing. When someone has to make a visit to the hospital for instance and return home a few days later, they’ll soon discover a mountain of bills from more sources than just the hospital. Doctors, pharmacies and other assistance can be listed on a statement. Insurance companies also receive these bills and typically will issue a payment within 30 days. Later, another round of monthly statements are sent showing a balance and what the insurance company paid. There are also deductibles to be considered and it can be months before a final settlement amount is arrived at. Consumers often dispute various charges during this same period. You can easily see why lenders pay little attention to medical collection accounts.
Non-medical issues however do warrant some attention. If the collection account is greater than $2,000, the FHA does require the lender to take 5.0% of the outstanding balance and apply it to the borrower’s debt ratio calculations. This can often be too much for the borrower to handle. In this instance, the borrowers can make payment arrangements with the creditor and once an agreement has been reached, by forwarding a copy of the payment arrangement to the lender, the lender can then use the monthly payment when qualifying the borrower.
Charged Off Accounts
Okay, now what happens when collection efforts fail and the lender simply gives up and charges off the account altogether, ending all collection efforts from that creditor? Using established FHA guidelines, the charged off account may be ignored completely with no monthly payments calculated in any method. No 5.0% rule and no minimum payment calculations at all. If a lender reviews a credit report with a charged off account the lender may still decline the application due to internal overlays. Finally, if a charged off account also lists a dispute, the loan cannot be approved.
Finally, let’s look at the bigger picture here. Both collections and charged off accounts will damage credit scores. If scores have drifted below minimum requirements, the loan may not be approved regardless of FHA guidelines. In many cases, if the negative activity is relatively recent scores will be impacted more compared to a collection account that is in the rearview mirror for two or three years.