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Does FHA require collections to be paid off for a FHA mortgage approval?

A Collection Account refers to a Mortgage applicant’s loan or debt that has been submitted to a collection agency by a creditor.

If the credit reports used in the analysis show cumulative outstanding collection account balances of $2,000 or greater, the lender must:

  • verify that the debt is paid in full at the time of or prior to settlement using an acceptable source of funds;
  • verify that the Mortgage applicant has made payment arrangements with the creditor and include the monthly payment in the Mortgage applicant’s Debt-to-Income ratio (DTI); or
  • if a payment arrangement is not available, calculate the monthly payment using 5 percent of the outstanding balance of each collection and include the monthly payment in the Mortgage applicant’s DTI.

Collection accounts of a non-borrowing spouse in a community property state must be included in the $2,000 cumulative balance and analyzed as part of the Mortgage applicant’s ability to pay all collection accounts, unless excluded by state law.   Unless the lender uses 5 percent of the outstanding balance, the lender must provide the following documentation:

  • evidence of payment in full, if paid prior to settlement;
  • the payoff statement, if paid at settlement; or
  • the payment arrangement with creditor, if not paid prior to or at settlement.

For manually underwritten loans, the lender must determine if collection accounts were a result of:

  • the Mortgage applicant’s disregard for financial obligations;
  • the Mortgage applicant’s inability to manage debt; or
  • extenuating circumstances.

The FHA mortgage lender must document reasons for approving a mortgage when the Mortgage applicant has any collection accounts. The FHA Mortgage applicant must provide a letter of explanation, which is supported by documentation, for each outstanding collection account. The explanation and supporting documentation must be consistent with other credit information in the file.

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