A charge off is a debt that you failed to repay according to the terms of the loan. There are stages a debt account passes through before it is charged off. In short, if you fail to pay a debt the account is classified as late (or delinquent), then it usually goes into collections (which means the creditor is still attempting to get you to repay the debt) and ultimately if you fail to bring the account current the creditor may charge off the account, which means they are no longer trying to get you to repay the debt.
If a creditor charges off a debt account, it appears as a charge off on your credit report for seven years. Even though the creditor has charged off the account, they may also sell the debt to a collections firm so the account may also show up on your credit report as in collections, which is a double whammy.
So how does a charge off impact your ability to get a mortgage?
A charge off affects your ability to qualify for a mortgage in multiple ways. Having a charge off, as well as the late or missed payments and an account in collections that preceded the charge off, can cause your credit score to drop up to 150 points. The lower your credit score, the more challenging it is to qualify for a mortgage and the higher your mortgage rate. If your credit score is too low, you may not be able to qualify for a mortgage or you may be ineligible for certain loan programs.
Depending on when the charge off occurred and if you ignored it, settled it for less than the full amount you owed or paid it off in full, your credit score may recover by the time you apply for a mortgage. This is why if you have a charge off it is important to check your credit score several months before you apply for a mortgage. Depending on your score, you may decide to move forward, try to resolve the charge off with the creditor or wait until your score improves before you apply for a mortgage.
Aside from the negative impact on your credit score, the good news is that a charge off typically does not prevent you from qualifying for a mortgage. Mortgage qualification guidelines regarding charge offs vary by lender and loan program. We outline how a charge off affects your ability to qualify for a conventional, jumbo, FHA, VA and USDA mortgage below.
Conventional Mortgage - Single-Unit Primary Residence. If you are buying a single unit property, you are not required to payoff the charge off and no additional debt payment is included in your debt-to-income. In short, the charge off has minimal direct impact on your ability to get approved for your mortgage.
Conventional Mortgage - Two-to-Four Unit Primary Residence or Second Home. Charge offs with an account balance greater than $5,000 must be paid off completely before your mortgage closes.
Conventional Mortgage - Investment Property. Any individual charge off accounts with a balance greater than $250 and accounts with a combined balance greater than $1,000 must be paid off completely before your loan closes.
Jumbo Mortgage. Qualification guidelines for jumbo mortgages vary by lender and are less standardized. Some lenders may not require you to address the charge off, some lenders may require you to provide a letter of explanation that addresses the issue and other lenders may require you to payoff or settle the charge off before closing, depending on the amount, creditor and date of the charge off. If you are applying for a jumbo mortgage we recommend that you check with the lender in advance to determine its charge off policy.
VA Home Loan. In most cases, applicants are not required to address the charge off and no additional debt payments are included in your debt-to-income ratio.
FHA Mortgage - Standard Underwriting. If your lender submits your mortgage application for review using the FHA’s standard underwriting process (also referred to as automated underwriting), the charge off does not need to be addressed and no debt payment payments are included in your debt-to-income ratio.
FHA Mortgage - Manual Underwriting. If your loan application requires an exception to an FHA qualification guideline, such as a lower than permitted credit score or higher than allowed debt-to-income ratio, your lender submits your application using manual underwriting. The manual underwriting process involves a more in-depth review of your application. If you have a charge off and your lender manually underwrites your application, the lender is required to provide documentation that supports why your application should be approved and you are required to provide a letter of explanation that outlines why the charge off occurred and the steps you took to address the issue. Depending on if the documentation provided by you and your lender is acceptable and the circumstances that caused the charge off, your mortgage may be approved or rejected.
USDA Home Loan - Standard Underwriting With Credit Score of at Least 640. If your credit score is at least 640 and your lender uses the USDA's Guaranteed Underwriting System -- an automated underwriting system -- then you should be able to qualify for a USDA home loan with the charge off. In this scenario, a letter of explanation is not required and no additional debt payments are included in your debt-to-income ratio.
USDA Home Loan - Manual Underwriting With Credit Score Less than 640. If your credit score is less than 640 and your lender manually underwrites your loan, the lender is required to submit a credit exception that explains the charge off. A credit exception is a written explanation of the circumstances that led to the charge off and the steps you, the borrower, took to address the issue. Depending on what caused the charge off, if it was a one-time situation and other circumstances, your credit exception and USDA home loan may be approved or rejected. In other words, to qualify for the mortgage, the USDA must grant you an exception.
Please note that manually underwriting a loan application, as described above for the FHA and USDA mortgage programs, requires additional work by the borrower and the lender. Not all lenders are willing to submit your application for manual underwriting so you may need to contact multiple lenders to find one you can work with.
Additionally, the guidelines outlined above are for specific mortgage programs and lenders may apply their own, more challenging internal underwriting requirements called lender overlays. In some cases a lender may require you to payoff a charge off to qualify for a mortgage even though the program guidelines do not require this.
The table below shows mortgage terms for leading lenders. We recommend that you contact multiple lenders as qualification guidelines may vary, especially as it relates to charge offs and other credit challenges. A charge off should not disqualify you from getting a mortgage but you need to find the right lender and loan program.
You can also use the FREEandCLEAR Lender Directory to search by lender and loan program. For example, you can search for lenders in your state that offer programs for credit-challenged borrowers.
Conventional Mortgage Charge Off Guidelines: https://www.fanniemae.com/content/guide/sel050119.pdf
FHA Mortgage Charge Off Guidelines: https://www.hud.gov/sites/documents/40001HSGH.PDF
USDA Mortgage Charge Off Guidelines: https://www.rd.usda.gov/files/3555-1chapter10.pdf