Can you get approved for an FHA loan with collections on your credit report? I make a good income but my credit score is low due to several accounts in collection and want to know if I can qualify for a mortgage.
It is certainly possible to qualify for an FHA mortgage with accounts in collection but you may need to set up a payment plan, depending on the amount you owe. The collections may also impact your credit score, which may affect your ability to get approved for the loan.
If the total balance of your collections is $2,000 or more, you are required to either pay off the account balance in full or establish a payment plan with the creditor. We should highlight that medical accounts in collection are excluded from your total account balance according to FHA program guidelines.
If you decide to pay off the account be sure to keep a record of your payment including an updated account statement as it can take several weeks or longer for your credit score to update. You do not want to delay the mortgage process because you cannot document that the collection has been resolved.
If you establish a payment plan, the monthly payment is included in your debt-to-income ratio, which may reduce the loan amount you qualify for. For example, if you agree to pay a creditor $200 a month to resolve an outstanding collections account, that payment is counted as debt when you apply for the loan. The higher your monthly debt expense, the lower the mortgage you can afford.
If you cannot agree to a payment plan with the creditor, the lender includes a monthly debt payment equal to 5% of the total collections account balance in your debt-to-income ratio. For example, if your outstanding collection account balance is $2,500, the lender adds $125 to your monthly debt expense ($2,500 * 5% = $125), even if you are not actually making the payments to the creditor.
If you earn sufficient income, then you should still be able to qualify for the loan even when the lender factors payments for the collections into your application. If you are on the borderline in terms of qualifying, however, then the higher monthly debt expense may disqualify you or reduce the mortgage you are eligible for.
Use ourFHA MORTGAGE QUALIFICATION CALCULATORto determine the loan you can afford based on your monthly income and debt expense
Additionally, regardless of the account balance, lenders typically request additional information about collections that appear on your credit report. Some lenders may be more flexible with a collection that occurred several years ago even if the account only recently showed up on your credit report. Additionally, as noted above, collections related to medical expenses or other special circumstances may be treated more favorably and are usually excluded by lenders.
In most cases it can be helpful to provide a letter of explanation that outlines why the collection occurred and the steps you took to resolve the issue. If you have not experienced any other collections or adverse credit issues you should also note that information in your letter.
The final point to keep in mind is that collections stay on your credit report for seven years so they may adversely affect your credit score long after you have settled the account. The magnitude of the impact depends on the amount of the account balance and when it went into collection.
The good news is the FHA program applies more flexible qualification guidelines for applicants with credit challenges. You can qualify for an FHA mortgage with a credit score as low as 500 if you make a down payment of at least 10% and a score of only 580 if you make a down payment between 3.5% and 10% of the property purchase price.
To summarize, just because you have accounts in collection does not mean you cannot get approved for an FHA loan. In fact, the FHA program is more forgiving for borrowers with credit issues such as collections. As long as you take the right steps to payoff or settle the account and you meet the minimum credit score requirement, you should be well positioned to qualify for the loan.
The table below shows leading FHA lenders in your area. We recommend that you contact multiple lenders to confirm that you are eligible for the FHA program. Shopping lenders is also the best way to save money on your mortgage.
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Sources
"II.A.4.b.iii.(A). Collection Accounts, Charge Off Accounts, Accounts with Late Payments in the Previous 24 Months, and Judgments (TOTAL)." FHA Single Family Housing Policy Handbook 4000.1. Federal Housing Administration, January 2 2020. Web.
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