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Qualifying for a home loan with collections, charge offs or judgements

Qualifying for a Home Loan with Collections, Charge Offs or Judgements

A lot of people have had challenges in the past, resulting in a collection, charge-off, or judgement showing up on your credit report.

It’s not as bad as you might think most of the time.

The primary decision maker is the automated underwriting engine from Fannie Mae called Desktop Underwriter (DU), or Desktop Originator (DO).  Both systems are identical with the underwriting guidelines that are followed.

The only differences between DU and DO is accessibility to the underwriter, and deliverability to Fannie Mae. The transfer of your loan approval from DO to DU is seamless, and a normal part of the process.

Below, you will find other exclusions form DU which include charge-offs and medical collections that will not be counted against you, and are not required to be paid off.

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Timing is Important

Timing is an important factor in determining how old collections will affect your approval.  Anything older than 24 months is generally ignored by DU.

Another important credit preservation fact is that you should not try to pay off old collection accounts.

Sometimes, advice is given to pay off old collection accounts, which only results in a temporary drop in your credit score as an aged delinquent account becomes a recent delinquent account as the status changes to “paid collection”.

It is usually best to leave accounts alone that are older than 24 months old.

Fannie Mae Conventional Guidelines

Past-Due, Collection, and Charge-Off of Non-Mortgage Accounts – Accounts that are reported as past due (not reported as collection accounts) must be brought current.

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If this were to occur, it could be an inaccuracy on the credit report that can be corrected.

For one-unit, principal residence properties, borrowers are not required to pay off outstanding collections or non-mortgage charge-offs, regardless of the amount.

Note: If the lender marks the collection account Paid By Close in the online loan application, DU will issue a message in the DU Underwriting Findings report stating that the collection must be paid.

For two-to-four unit owner-occupied and second home properties, collections and non-mortgage charge-offs totaling more than $5,000 must be paid in full prior to or at closing.

For investment properties, individual collection and non-mortgage charge-off accounts equal to or greater than $250 and accounts that total more than $1,000 must be paid in full prior to or at closing

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Risk Factors Considered by DU

Public Records, Foreclosures, and Collection Accounts

If your credit history includes any significant derogatory credit event, you could be considered high risk.

Significant derogatory credit events include bankruptcy filing, foreclosure, deed-in-lieu of foreclosure, pre-foreclosure sale, mortgage charge-off, judgments, tax liens, or accounts that have been turned over to a collection agency.

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The more recent such events occurred, the more adverse the impact is on the credit profile.

Although most public record information is retained in the credit history for seven years (ten years for bankruptcies), as time passes, it does become less significant to DU’s credit evaluation.

FHA Guidelines on Judgments (TOTAL)

Judgment refers to any debt or monetary liability of the Borrower, and the Borrower’s spouse in a community property state unless excluded by state law, created by a court, or other adjudicating body.

Your Lender must verify that court-ordered Judgments are resolved or paid off prior to or at closing. Judgments of a non-borrowing spouse in a community property state must be resolved or paid in full, with the exception of obligations excluded by state law.

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Exception: A Judgment is considered resolved if the Borrower has entered into a valid agreement with the creditor to make regular payments on the debt, the Borrower has made timely payments for at least three months of scheduled payments and the Judgment will not supersede the FHA-insured mortgage lien.

FHA Guidelines:  Obligations Not Considered Debt

  • medical collections
  • federal, state, and local taxes, if not delinquent and no payments are required
  • automatic deductions from savings, when not associated with another type of obligation
  • Federal Insurance Contributions Act (FICA) and other retirement contributions, such as 401(k) accounts
  • collateralized loans secured by depository accounts
  • utilities
  • child care
  • commuting costs
  • union dues
  • insurance, other than property insurance
  • open accounts with zero balances
  • voluntary deductions, when not associated with another type of obligation

Collections and Open Derogatory accounts should follow DO or DU findings.

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VA Guidelines on Derogatory Credit

In circumstances not involving bankruptcy, satisfactory credit is generally considered to be reestablished after the veteran, or veteran and spouse, have made satisfactory payments for 12 months after the date the last derogatory credit item was satisfied.

For example, assume a credit report reveals several unpaid collections, including some which have been outstanding for many years.

Once the borrower has satisfied the obligations, and then makes timely payments on subsequent obligations for at least 12 months, satisfactory credit is reestablished.

Collections: Isolated collection accounts do not necessarily have to be paid off as a condition for loan approval. For example, a credit report may show numerous satisfactory accounts and one or two unpaid medical (or other) collections.

In such instances, while it would be preferable to have collections paid, it would not necessarily be a requirement for loan approval.

However, collection accounts must be considered part of the borrower’s overall credit history and unpaid collection accounts should be considered open, recent credit.

Borrowers with a history of collection accounts should have reestablished satisfactory credit (see previous paragraph) in order to be considered a satisfactory credit risk.

Remove Disputes on Credit Report

All disputed items on your credit report need to be removed prior to submission to an underwriter.

You can have disputes removed by contacting the company that put the disputes on for you, or you can contact the credit agencies directly and ask to have the dispute removed.

If a dispute is on a recent delinquent account, it could affect your credit score once the dispute is removed.  Most older disputes will not affect your credit score in my experience.

Need a Second Opinion?

The most important thing to remember is that medical collections and charge-offs are generally not counted against you.

If you’re doing this research to try to figure out if you should even try to get pre-approved, don’t get pre-approved, it’s probably not as bad as you think.

If you’re not sure, and you need a second opinion, I’m pretty easy to reach, and happy to help.

Feel free to ask any questions below, or by email.  This is an opportunity for you to anonymously ask an experienced professional that has absolutely no financial interest in how they answer your questions.

About Your Expert

Scott Schang

A 20 year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues, and making sense of complicated real estate and mortgage topics on this website since 2007

Leave a Question or Comment About this Topic

  • Scooter says:

    Scott,

    I’m in Texas, and I have a judgement (default on a debt cons. loan) that was placed on me over 12 years ago. From what I can see via the county clerks website, the plaintiff has never filed a motion to the court to revive the judgement, the statute of limitations have passed which in turn the judgement is now dead. I’m in the process of buying a home and I’ve received my pre-approval with flying colors as my credit is on par with no blemishes. I’ve discussed this judgement with my loan officer at the mortgage company and he’s assured me that this will not be an issue. I’m still a bit weary that the underwriter or title company will come across this public record (which is inevitable) and its possibly going to cause an issue. With all this being said, will a dead judgement keep me from getting the home loan?

    • Scott Schang says:

      Hey Scooter, this is a really good question. What kind of loan are you approved for? The guidelines for dealing with judgements may vary from one loan type to the next. Your lender or underwriter may also have rules that are more strict than Fannie Mae or FHA guidelines. I agree with your loan officer that should not affect your approval, but I would push to have your loan officer email this question to the underwriter so that you have their answer in writing.

      Worst-case scenario, you may need to either get the judgement removed (which could poke a sleeping bear) or make payment arrangements with the creditor, which those payments will be calculated in your debt to income ratios.

      Push this with your loan officer. If it’s a deal killer, you want to know now so you can address it and get back on track.

      Hope this helps?

      • Scooter says:

        Scott, I’m approved for a VA home loan. Good point on having the loan officer contact the underwriter, I’d like to have an answer on this before we’re in too deep. I’m still in my option period and haven’t signed the loan offer.

        • Scott Schang says:

          THANK YOU for your Service! If the judgement appears on your credit report, and you have an automated underwriting approval, you’re in the clear.

          If the file was downgraded to a manual underwrite, then it’s going to be an underwriter call. Experienced VA loan officers know that sometimes you have to fight for the Veteran. The VA is very flexible and will make every attempt to rule in the Veteran’s favour.

          If you run into anything else, feel free to email me directly at scott@findmywayhome.com

          • Scooter says:

            Scott, thank you! Another note, the judgement in not my credit report at all. My loan officer confirmed this twice.

  • Jay says:

    Scott, I’m less than 2 weeks away from my settlement date to purchase a new home. Two days ago I received notice via credit karma that something went into collections. The collection agency was SW Credit Systems, I received no notice about the bill and didn’t know a balance remained. The bill was for $400 for cable tv equipment I forgot to return 3 years ago after moving. I immediately paid the bill upon being notified but my credit already dipped 35 points and lowered my FICO score. I’m extremely worried this will effect underwriting and jeopardize my home loan. Can you please share any information or advice?

    • Scott Schang says:

      Hi Jay, these are different times right now with the COVID-19 crisis, and lenders are being extra cautious. Typically, your credit is not pulled while in the process unless the credit report has expired and a new one is required.

      This is touchy. I am inclined to say that you should bring this to the loan officer’s attention to get in front of any surprises. But I’m also a little nervous that if they tell the underwriter what happened, that will cause them to take a closer look.

      Is it possible to reach back out to the creditor and ask them if they will remove the collection reporting on your credit report? They got their money, so it’s not like they feel like they need to play hardball with you.

      I would try this first. If you can get the collection reporting removed, it’s a moot point. Next, I would suggest having this conversation with your loan officer.

      Here’s the bottom line….if they are going to do a soft pull and see that the score went down, you want to know if that’s going to be a problem now. Sooner than later.

      So, that’s my advice. See if the creditor will remove the collection now that they are paid, and reach out to your loan officer and get in front of this. Both of those options are much better than doing nothing.

      Hope this helps?

  • Robert Klimeck says:

    I have a judgement of $5,000, from a old landlord. I am a 100% disabled veteran with the VA. Is it possible to ask for a 4% seller and or lender concession/credit to pay for it, plus requesting seller to pay for closing costs?

    • Scott Schang says:

      Hi Robert, first and foremost THANK YOU for your Service! Now, your question…unfortunately, judgements need to be either paid or have payment arrangements with 3 consecutive months of payments made. You are not allowed to use lender or seller concessions to pay a judgement when you are purchasing a home. If you owned the home already, you could refinance and pay the judgement from your equity, but it doesn’t sound like that’s your situation.

      Here is one possible solution to your challenge – If the lender is charging any fees at all, and that is the reason that you do not have money left over to pay the judgement, that’s an easy fix. You should be able to have 100% of your closing costs paid by either the seller, the lender and even your real estate agent. That would free up that money so that it can be used to pay off the judgement.

      As I’m writing this, a thought crossed my mind. Is this a judgement that shows up on your credit report? Or does it show up on your credit as a charge-off or collection? If it’s a charge-off or collection, that may not have to be paid.

      If you have any other questions, or would like an introduction to a VA loan specialist that I know and trust, feel free to email me directly at scott@findmywayhome.com

      I Hope this helps?

  • Bonney Waters says:

    I have a charge off from a large timeshare loan that is less than a year old. My FICO score is 766 and my vantage score is 795. I’m applying for a refi and the lender is saying the charge off is effecting my debt to income ratio thus will cause problems for me. So, am I just out of luck?

    • Scott Schang says:

      Hi Bonney, there have been recent changes to Fannie Mae guidelines that do not consider timeshare charge-offs as a mortgage delinquency. If the account is charged off, you should be able to ignore it.

      I would like to introduce you to someone that I know and trust for a second opinion. If you would like, shoot me an email to scott@findmywayhome.com, let me know what State you’re in, and the best way to reach you.

      Hope this helps?

  • Mike says:

    Mortgage company is asking for an explanation for charge off that is over 4 years old. What do I tell them?

    • Scott Schang says:

      There is no wrong answer. If you’re not interested in providing an explanation, get a second opinion. It’s as simply as you experienced a temporary financial hardship. You are typically not required to count charge-offs against you in most cases, and the DU automated underwriting system ignores them.

      Just tell the truth about the charge-off. That’s always the best policy. They are asking just to do their due diligence.

      Hope this helps?

      P.S. If you would like a second opinion, shoot me an email to scott@findmywayhome.com and let me know what State you’re in. I have very smart and experienced friends 🙂

  • Debera Bonner says:

    Closed Collection Accounts are they held against you

    • Scott Schang says:

      Initially, recent activity on a collection account will bring your score down a little. There are many factors that go into your score, including on-time payments and low balances on credit cards (revolving debt). We typically only suggest that you pay off collections or charge-offs in exchange for then removing it entirely from your report, in which case there is no temporary drop after paying.

      Hope this helps?