Th HUD 4000.1 FHA Handbook must be followed by approved FHA Mortgage Lenders and FHA Mortgage borrowers and there are guidelines in regards to collection account – charge off accounts that must be strictly adhered to. Many of our clients at The Larry Stepp Team @ Gustan Cho Associates are borrowers who have been turned down by other banks and mortgage companies because of outstanding collection account – charge off account (s). This experience has made many aware of the FHA Guidelines on Collection Accounts and have realized that FHA does not require them to pay off outstanding collection account – charge off accounts to qualify for a FHA Loan. Borrowers are left wondering why they were advised they do not qualify with a lender or a bank for a FHA Loan unless they pay the outstanding collection account – charge off accounts. Borrowers that get turned down one lender due to collection accounts may be able to qualify for FHA at another FHA approved lender. This is an example of an overlay, an overlay is a Lender guideline that is more stringent/strict above minimum guidelines, this is perfectly legal and the majority of lenders have overlays. However, the minimum FHA guidelines do not require a borrower to pay off old collection account – charge off accounts. So the question is, “Do I have to pay off old collection account – charge off accounts to qualify for a FHA loan”? The short and factual is “NO”, not according to minimum FHA guidelines.
Even though FHA minimum guidelines does not require a borrower to pay off old collection account – charge off accounts, there are some rules pertaining to them, such as. Unpaid non-medical collection accounts with outstanding collection balances can have an impact on a borrowers debt to income ratio, (DTI). According to FHA guidelines collection – charge off accounts are classified in one of three categories.
FHA minimum guidelines do NOT require non-medical accounts with outstanding balances to be paid off, but here’s where it can be confusing. If the sum total of outstanding unpaid NON-MEDICAL accounts is more than $2,000, FHA will will require the lender to to calculate 5% of the non-medical outstanding balance and add that figure into the monthly debt responsibility of the borrower. Whether or not they are making payments on the debt or not, for example: Borrower had a total of $3000.00 of non-medical collection accounts:
$3000 x .05 = $150.oo
This $150 must be counted into the monthly debt of the borrower, just like a car payment or credit card payment. The borrower of course is not actually making a $150 payment but this is a monthly paper-debt according to FHA minimum guidelines. Therefore the $150 in this example is counted towards DTI. In some cases the 5% of outstanding balance can be a pretty big hit against DTI and disqualify a buyer from a new mortgage loan. For example, say the unpaid Non-Medical account were $10,000:
$10,000 x .05 = $500. A $500 added into monthly obligation will be as much as a house payment, how many people can qualify based on income for a house payment and another $2,000 ? Further this added paper expense will exceed maximum allowed DTI per FHA Guidelines on Debt to Income ratios. However, the borrower can contact the creditor and make payment arrangements with he creditor or collection agency, when the agreement is made a written copy of the agreement can be used in lieu of the 5% of the outstanding collection account, so using the same $10,000 sum total balance. If the borrower makes an agreement to pay $100 a month on their monthly debt then the $100 is counted toward the DTI, not the $500 (5% of the $10,000 sum total). Let’s follow this case scenario through from beginning to end:
$10,000 unpaid non-medical collection account, following FHA minimum guidelines we must use 5% of this balance calculated into the DTI. $10,000 x .05 = $500.00 On the other hand if the borrower makes a payment agreement with the creditor or collection agency for $100.00 monthly payment then the $100.00 is calculated into the DTI. A $500 monthly payment calculated into a borrower’s DTI can have significant impact, many people have $20,000 or even $30,000 to $50,000 in unpaid non-medical collection account – charge off accounts. This can add up significantly. For a borrower to overcome this would require above average income. FHA minimum guidelines allow a maximum of 56.9% back end DTI for FHA borrowers with FICO credit scores greater than 620. For borrowers with FICO score less than 620 the maximum allowed DTI is 43%. Doing a math scenario, consider this, most borrowers have car payments and at least a credit card payment backend DTI is all debt including house payment. If a borrower makes $4500.00 monthly income and has $10,000 in non-medical collection account sum total with no payment arrangement the lender must use $500.00 as a paper monthly debt, this 500, represents 11.1% of their allowable DTI before adding, car payments, credit card payments and house payments. Following through with this example. Borrower has two tradelines (credit cards) and monthly payments on these total $175.00 and only one car payment of $450.00. Now if we add these up:
Looking further into this example if their were a monthly payment agreement in place for the unpaid collection then the actual real payment is calculated into the DTI. Assuming the agreed payment is $150.00 monthly. The DTI changes to, 17.2% front end, 50% DTI back end. Provided the borrower has a FICO score no less than 620 they are well within the allowable maximum DTI.
What about those unpaid Medical collection account – charge off accounts ? Medical collection account – charge off accounts are exempt from DTI calculations no matter how large the outstanding unpaid medical collection account is or no matter how much the medical charge off accounts total.
Although many, maybe even the majority of lenders will require a borrower to pay off old unpaid collection account – charge off accounts before they will qualify you for a new mortgage does not mean they are doing an illegal action. In fact FHA Lender Overlays are common within the mortgage industry even though HUD guidelines do not require old unpaid outstanding collection account – charge off accounts to be paid to qualify for a FHA mortgage loan. Some lenders may not require unpaid collection account – charge off accounts to be paid to qualify but may cap the amount of the collection account or charge off accounts, example maybe not more than $5,000. As stated this is not illegal and common in the Mortgage industry. Since the mortgage and real estate meltdown of 2008, there are many families and individuals with derogatory credit accounts on their credit profile and their are strict guidelines that must be followed to qualify. However, people are not a FICO score or a credit history, life happens when you are making other plans is what my Mother often reminded me, The Larry Stepp Team at Gustan Cho Associates understand this and are willing to guide and assist you through the maze. Our Team is available 7 days a week, holidays and weekends.
Larry Stepp 407-922-4755 LarryS.HomesNetwork@gmail.com