Despite their best efforts, people today are having trouble making ends meet and paying their bills, which can affect their ability to obtain a mortgage. Recognizing this, the Federal Housing Agency (FHA) has made changes to their credit guidelines to account for how collections and disputed accounts are handled. These FHA changes affect case numbers (a unique 10-digit number assigned to your file on the FHA website) assigned on or after October 15, 2013.
While the FHA does not need collection accounts to be paid off to be approved for a mortgage, these unpaid collections could affect your ability to repay your mortgage. Therefore, to mitigate this risk, the FHA now requires a capacity analysis when these collection accounts have a combined balance of $2,000 or more.
What is a Capacity Analysis?
A capacity analysis looks for the following:
- Before or when a home sale closes, the collection amount must be either paid in full or the amount of money needed to pay the balance has a verified, acceptable source.
- You have arranged payment with each creditor, and each creditor has given a credit letter indicating the monthly payment they will receive. This payment will be included in your debt-to-income ratio. If you cannot prove a payment arrangement, then the lender will calculate the payment using 5% of the outstanding balance of each collection, which will be included in your debt-to-income ratio.
- If you have outstanding collections or judgments, you need to provide a letter of explanation, along with any documentation, to your lender.
Before mortgages are eligible for FHA insurance, all judgments must be paid, except when you and your creditor agreed on a payment schedule. For court-ordered payments, you must give a copy of this agreement to your lender, prove that payments were made, and have made at least three months of scheduled payments before being you can be approved for credit. Lenders must include the payment amount when calculating your debt-to-income ratio.
If you have any issues with accounts in your credit report, they must be reviewed by an underwriter. These accounts will not be considered in the credit score when rating your application. However, the FHA requires the lender to consider them in the underwriting analysis.
The FHA changes affect how applications with disputed derogatory accounts are downgraded to factor in issues such as the age and size of the outstanding balance. These accounts include:
- Accounts having late payments within the previous 24 months
If you are disputing a derogatory account, then you must provide a letter of explanation and documentation to support your claim. The amount of all derogatory accounts combined will determine if your loan is downgraded or not:
- If the combined amount is equal to or greater than $1,000, then the mortgage application must be downgraded to a Refer and a Direct Endorsement underwriter is required to underwrite the loan manually.
- If the combined amount is less than $1,000, then a downgrade is not required.
Derogatory Account Exclusions
The following accounts are excluded from the derogatory account total:
- Disputed medical accounts. They also do not require documentation.
- Disputed accounts due to identity theft, credit card theft, or unauthorized use. However, the lender must provide a credit report, a letter from the creditor, or other appropriate documentation to support your dispute.
- Disputed derogatory credit accounts of a non-purchasing spouse in a community property state are excluded in the cumulative balance for determining if the mortgage application is downgraded to a Refer.
Non-derogatory Accounts and Exclusions
The FHA changes affect how applications for non-derogatory disputed accounts are downgraded to factor in issues such as the age and size of the outstanding balance. These accounts include the following:
- Accounts having a zero balance.
- Accounts having one or more late payments and that are 24 months or older.
- Accounts that are paid and current.
If you are disputing a non-derogatory account, or are disputing an account which is not indicated on your credit report as being disputed, then your lender does not have to downgrade your application to Refer. However, the lender must understand how the disputed accounts affect your ability to repay the loan. If the dispute results in your monthly debt payments used to calculate the debt-to-income ratio being less than the amount indicated in your credit report, then you must provide documentation of the lower payments.
Note that medical collections or charge-off accounts are excluded in these recent changes. Non-derogatory disputed accounts are not included in the $1,000 amount, and both non-derogatory disputed and disputed accounts are not listed on your credit report.
You never know when issues can occur financially, but they do not have to affect you for the long haul. If you have any questions or need additional guidance about your specific mortgage situation regarding these FHA changes, ask your mortgage lender for complete details and exclusions or find out what you qualify for now.