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Can You Qualify for a Mortgage with a Charge Off?

Can you qualify for a mortgage with a charge off?

Michael Jensen, Mortgage and Finance Guru
, Mortgage and Finance Guru

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), as long as the charge off is not related to government-insured debt such as a student or SBA loan, the charge off does not need to be addressed and no additional payment are included in your debt-to-income ratio.  If the charge off is for a government-backed loan then you may be required to resolve the charge off or wait before you can qualify for an FHA mortgage. 

The table below shows mortgage terms for top-rated lenders near you.  We recommend that you contact multiple lenders to confirm their qualification guidelines regarding charge offs.  Shopping lenders also enables you to find the lender and mortgage program that best meet your needs.

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Current FHA Mortgage Rates as of July 5, 2020
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Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click for more information on rates and product details.

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 if the charge off is not for a government-backed loan, a letter of explanation is not required, you do not need to pay off the charge off and no additional debt payments are added to your debt-to-income ratio, unless you have already entered into a repayment plan.  If the charge off is for a government-insured loan, you may be required to address the charge off or satisfy a waiting period before you are eligible for a USDA home loan.

USDA Home Loan - Manual Underwriting With Credit Score Less than 640. If your credit score is less than 640 due to the negative impact of the charge off or other factors, the lender may be required to manually underwrite your loan.  In this scenario, the lender is usually required to submit a credit exception that addresses any significant credit issues and explains why you should be approved for the mortgage.  Although you are not required to provide a credit exception specifically because of the charge off, you may be required to address the charge off if it contributed to the reason why your application requires manual underwriting.  Regardless of how your application is underwritten, however, USDA home loan program guidelines do not require you to pay off charge offs, although in some cases this may be helpful.  

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.

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.

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Sources

"B3-5, Are collection accounts and non-mortgage charge-offs required to be paid off?"  Selling Guide: Fannie Mae Single Family.  Fannie Mae, December 4 2019.  Web.

"II.A.4.b.iv.N. Charge Off Accounts."  FHA Single Family Housing Policy Handbook 4000.1.  Federal Housing Administration, January 2 2020.  Web.

"Chapter 10, Attachment 10-A, Charge-Offs."  Single Family Housing Guaranteed Loan Program Technical Handbook.  U.S. Department of Agriculture, 2020.  Web.

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About the author

Michael Jensen, Mortgage and Finance Guru

Michael is the co-founder of FREEandCLEAR. Michael possesses extensive knowledge about mortgages and finance and has been writing about mortgages for nearly a decade. His work has been featured in leading national and industry publications. More about Michael

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