Quick Summary
- If the amount of your collections exceeds $2,000, you can either pay it in full or establish a payment method. DTI will be impacted by this.
- Your lender might simply add 5% of your collection balance to your monthly debt payments if your collections total more than $2,000 and you are unable to pay them all. DTI will be impacted by this.
- You normally don’t have to pay if your collections total less than $2,000 per month.
- The $2,000 estimate does not apply to medical collections.
When a loan or debt is in collections, it means that the borrower didn’t pay it back on time, and the original creditor sent the overdue debt to a third party for collection.
Some applicants for FHA loans might have debt collections and worry about how their credit problems will affect their application. FHA loans are renowned for being tolerant of borrowers’ credit histories and debt-to-income (DTI) ratios, though.
What does this entail for those seeking FHA loans but who have collections? Can you still be approved for an FHA loan?
The answer is yes, but it also depends on your specific circumstances.
Requirements for FHA Loans if You Have Collections
Both conventional loans and loans backed by the government examine each borrower’s financial history to make sure they are a low-risk customer. To confirm this, they check people’s credit scores, DTIs, and income. Since FHA loans are insured by the federal government, the requirements are more lenient.
The standard requirements are:
- A credit score of at least 580 to qualify for 96.5% financing (or a down payment of 3.5%). If your credit score is between 500 and 579, you may still be eligible, but you must put down a minimum of 10%.
- DTI ratio of no more than 43%. The maximum DTI is 57%, but this will only be taken into account if you have compensating factors like a high credit score or a high down payment percentage.
- Two years of stable employment and income.
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. You cannot be approved for an FHA loan if your credit score is less than the required 500.
Whether the total balance of your collections is greater than or less than $2,000 will affect how the FHA handles collections.
Collections of Medicine are Not Included
Be aware that in accordance with FHA program requirements before we continue addressing how collections can impact your application for an FHA loan, medical accounts in collections are excluded from your total account balance. It won’t be included in the $2,000 collection calculation, therefore. However, it may still have an impact on your credit score and, consequently, your ability to obtain an FHA loan.
We’ll be concentrating mostly on non-medical collections in this piece.
The overall collection balance is over $2,000
If your total collection balance exceeds $2,000, you have two options: pay the balance in full or set up a payment plan.
If you pay off the balance in full, keep in mind that this will not improve your credit score. It will simply appear in your credit report as “paid” rather than “unpaid.” However, this may still have an impact on the lender’s decision.
Furthermore, if you establish a payment plan, your debt payments will be included in your DTI. Remember that a DTI of no more than 43% is the general requirement for FHA loans.
Plan B for Collections Over $2,000
If you have more than $2,000 in collections and are unable to pay them or set up a payment plan, the lender may calculate 5% of your outstanding balance and add it to your monthly debt payments. This will, of course, be included in your DTI.
For example, if your total collections are $5,000, the 5% calculation equals $250. As a result, even if you are not paying for it, $250 will be added to your monthly debt payments.
If you have a high income, you should be able to qualify for the loan even if the lender includes payments for collections in your application. However, if you are on the verge of qualifying, the higher monthly debt expense may disqualify you or make you ineligible or reduce the mortgage you are eligible for.
The total collection balance is less than $2,000
Generally, if the outstanding balance on your collections is less than $2,000, you are not required to pay them.
Whatever your situation is, it’s best to talk to find the right lender in your area and hash it out with your loan officer.
Debt collection will not disqualify you from an FHA loan.
When compared to conventional loans, FHA loan standards are far more flexible and permissive. It includes a low minimum credit score and down payment criteria, as well as a flexible DTI. This makes it easier for folks with less-than-perfect credit, especially those with debt collectors, to purchase a property.
Your eligibility for FHA loans reverts to the usual requirements. Despite having collections, the basic line is that you’re fine as long as you meet the credit score and DTI requirements.
FAQs
What Qualifies You for an FHA Loan?
Failure to meet the FHA loan conditions will result in disqualification. The three most common explanations are:
- Your credit score is insufficient.
- Your DTI ratio is excessively high.
- You lack sufficient funds to meet the down payment and closing expenses.
Should I pay off all of my debts before purchasing a home?
It is always advisable to pay off your debts before purchasing a home. This can enhance your credit score and DTI ratio, allowing you to qualify for any sort of loan with greater ease and flexibility.
Is it Possible to Buy a House with a Paid Collection?
It is possible to purchase a home with collections, both unpaid and paid. This will be determined solely by the sort of house loan you apply for, the type of debt you have, and the lender’s unique requirements. You can even buy a home using the FHA 203k loan program with collections as well.