Having collections means that someone failed to pay their loan or debt on time, and thus the original creditor sends it to a third-party person or agency to collect the overdue debt.
Some FHA loan applicants may have these debt collections and stress over how these credit issues will affect their FHA loan application. However, FHA loans are known for their flexibility when it comes to people’s credit scores and debt-to-income (DTI) ratios.
So what does this mean for FHA loan applicants that have collections? Is it still possible to qualify for an FHA loan?
The answer is – yes, it just depends on your particular situation.
FHA Loan Requirements if You Have Collections
Government-backed and conventional loans alike look at the financial history of every borrower to ensure that they are a non-risky person to lend to. And so they check for credit scores, DTIs, and income to verify just that. FHA loans happen to have more flexible requirements since it is insured by the federal government.
Here’s a rundown of the standard FHA requirements:
- A credit score of at least 580 to qualify for 96.5% financing (or a down payment of 3.5%). You can still qualify with a credit score under that, but you’ll need to chat with the lender to see what’s possible.
- DTI ratio of no more than 43%. A DTI of up to 57% is the maximum but this will be only considered if you have compensating factors like a high credit score or a high down payment rate.
- Stable income and employment history of two years. Stability is key here.
Although collections itself will not stop you from qualifying for an FHA loan (including FHA refinances), it is a known fact that it can negatively impact your credit score.
If your credit score is under the minimum of 500, you will not be able to qualify for an FHA loan.
The FHA’s guidelines on collections depend on whether the total balance of your collections is more than or less than $2,000.
Medical Collections are Excluded
Before we continue discussing how collections can affect your application for an FHA loan, know that according to FHA program guidelines, medical accounts in collections are excluded from your total account balance. That means that it will not be counted into the $2,000 collection calculation.
However, it can still affect your credit score thus affecting your chances of qualifying for an FHA loan.
In this article, we will be primarily focusing on non-medical collections.
Total Balance of Collections is More than $2,000
If your total balance of collections is more than $2,000, you have two options – paying the balance in full or setting up a payment plan.
If you pay the balance in full, note that this won’t improve your credit score. It will simply show up as “paid” in your credit report instead of “unpaid”. But this still may positively influence the decision of the lender.
Moreover, if you set up a payment plan, this will mean that your debt payments will be part of your DTI. Remember that the general requirement for FHA loans is a DTI of not more than 43%.
Plan B for Collections Exceeding $2,000
If you have collections that exceed $2,000 and you can’t pay them or set up a payment plan, another option is for the lender to calculate 5% of your outstanding balance and add it to your monthly debt payments. Of course, this will be included in your DTI.
For example, if your collections total $5,000, the 5% calculation will equal $250. Therefore, $250 will be added to your monthly debt payments, even if you’re not paying for it.
If you’re a high income-earner, then you should still be able to qualify for the loan even when the lender factors payments for the collections into your application. However, if you are on the borderline in terms of qualifying, the higher monthly debt expense may disqualify you or reduce the mortgage you are eligible for.
Total Balance of Collections is Less than $2,000
Typically, you don’t have to pay your collections if their outstanding balance is less than $2,000.
Whatever your situation is, it’s best to have a brief chat with an FHA lender near you and hash it out with your loan officer.
Debt Collections Will Not Automatically Disqualify You From an FHA Loan
FHA loan requirements are considerably more flexible and lenient compared to conventional loans. It has a low minimum credit score and down payment requirements with flexible DTI requirements too. This makes it easier for those with less-than-stellar credit history to purchase a home, including those with debt collections.
Your eligibility to qualify for FHA loans goes back to the standard requirements. Despite having collections, the bottom line is that as long as you fit the credit score and DTI requirements, you’re good to go.
Frequently Asked Questions
What will disqualify you from anFHA Loan?
Failure to meet the requirements for an FHA loan will get you disqualified. The most common three reasons are:
- Your credit score is too low.
- Your DTI ratio is too high.
- You do not have enough funds to cover the down payment and closing costs.
Should I pay off all my debt before buying a house?
It is generally a good idea to try and pay off as much debt as you can before buying a house, but you don’t want to pay everything off and put yourself in a bind.
At the end of the day it’s a balancing act. You want to pay off just the right amount so that you still have money left over for down payments, etc.
If you think you need some help with this, just give us call – we’d be happy to run the numbers and give you some options.
Can I buy a house with a paid collection?
It is possible to buy a house with collections, unpaid and especially paid. This will just depend on the type of home loan you are applying for, the type of debt you have, and the lender’s specific requirements. You can even buy a home using the FHA 203k loan program with collections as well.
