California Mortgage News

Does FHA require collections to be paid off

May 25th, 2016 11:24 AM by George Coronado

Does FHA require collections to be paid off for a borrower to be eligible for FHA financing?


A Collection Account refers to a Borrower’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 Borrower has made payment arrangements with the creditor and include the monthly payment in the Borrower’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 Borrower’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 Borrower’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 Borrower’s disregard for financial obligations; 
•     the Borrower’s inability to manage debt; or 
•     extenuating circumstances.  

The lender must document reasons for approving a mortgage when the Borrower has any collection accounts. The Borrower 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.