Since buying a home is a big (and exciting!) investment, many people have questions surrounding the financial part of the process. Whether it’s, “Can I take out a personal loan to cover a house downpayment?”, or, “How much should I put aside for annual house maintenance?” There are a lot of important questions to be asked.
A common question we hear is, "Can I buy a home if I have collections on my credit report?" Fortunately, the answer is yes. But it depends on how much money you owe and what type of debt it is.
Here are some things you should know if you have collections but want to buy a home.
The Good News: Your Situation Doesn’t Have to be Perfect.
Mortgage lenders expect you to have some debt, almost everyone does. To them, it's more important to know what type of debt you have, how much you owe, and whether you are making regular payments on your debts. They also want to know if you have any “derogatory credit.”
Derogatory credit includes, among other types, “collections” and “charge-offs:”
- Collections are unpaid debts forwarded to a lender’s collections department or an outside agency. Collections show on your credit report, and outstanding collections will raise concerns for lenders.
- Charge-offs are debts that cannot be collected and are written off by the lender. Any debt overdue (120 days for loans, 180 days for credit card debt) must be written off. Bankruptcy debt is also written off.
Charged-off debt is not forgiven and will show up on your credit report for seven years. Lenders may also sell charge-offs to collection agencies who may try to collect the debt until the statute of limitations runs out in your state.
Look for the Exceptions
All lenders have a limit for the amount of money in collections they allow a borrower to have. Traditional lenders may not work with a borrower who has any collections on their credit report. But there are exceptions.
A lender may ask a borrower to prove that a certain amount in collections has already been paid or prove that a repayment plan was created. Other lenders may be more flexible. For example, with a TruePath Mortgage, a person is allowed to have up to $1,000 in collections or up to $3,000 in medical collections and still be eligible for a loan.
Know Your Ratios
Lenders look at your credit report to see what significant monthly debts you have, including collections and charge-offs. Using these figures, they calculate your debt-to-income ratio (DTI). A good rule of thumb is to aim for a DTI of around 36%.
Your DTI allows the lender to evaluate how much you can afford to borrow considering the payments you need to make on a regular basis. Most lenders want a borrower to have a DTI below 43%.
With exceptions, your lender may require you to pay off any collections and charge-offs on your credit report. Even if your DTI is within a healthy range, the loan officer may indicate collection items are delaying loan approval.
The Great News: Help is Out There
This can feel overwhelming at first, but there are professionals out there who can help you get a grasp on what you have, what you owe, and what you can afford. For instance, Twin Cities Habitat for Humanity financial coaches can help you build a budget, set up payments for your collections, and increase your credit score.
Regardless of what a lender requires, you can start to strengthen your financial situation now. Pull a free credit report as soon as you think about buying a home. This will help you understand where you are financially and give you time to create a plan to improve your finances if you need to.
FAQs
Traditional lenders may not work with a borrower who has any collections on their credit report. But there are exceptions. A lender may ask a borrower to prove that a certain amount in collections has already been paid or prove that a repayment plan was created. Other lenders may be more flexible.
Can I get approved for a home loan with collections? ›
If you have unpaid collections that are not medical-related, it's possible that your FHA loan eligibility may be impacted. The FHA does not require collections to be paid off entirely in order for a borrower to be approved.
Can you get an FHA loan if you have collections? ›
Also, "FHA does not require that collection accounts be paid off as a condition of mortgage approval. However, court-ordered judgments must be paid off before the mortgage loan is eligible for FHA insurance endorsem*nt."
Do mortgage lenders look at paid collections? ›
"If you're trying to acquire a mortgage, removing or paying off a collection account is vital since the No. 1 factor lenders are looking at for approval is your payment history," Noisette says. Medical collections do not need to be paid for FHA loan approval, but your lender may require this.
Will collections stop you from getting a mortgage? ›
Getting a Conventional Loan With Charge-Offs, Collections, and Late Payments. Any negative mark on your credit can impact your score and reduce your chances of qualifying for a mortgage. This is especially true if you have debts that are late (past due), charged off, or currently in collections.
Can you have a 700 credit score with collections? ›
It is theoretically possible to get a 700 credit score with a collection account on your credit report. However, it is not common with traditional scoring models. A derogatory mark like a collection account on your credit report can make it incredibly difficult to obtain a good credit score like 700 or over.
Should I pay off a 2 year old collection? ›
Paying off collections could increase scores from the latest credit scoring models, but if your lender uses an older version, your score might not change. Regardless of whether it will raise your score quickly, paying off collection accounts is usually a good idea.
How to remove collections from a credit report? ›
You can ask the creditor — either the original creditor or a debt collector — for what's called a “goodwill deletion.” Write the collector a goodwill letter explaining your circ*mstances and why you would like the debt removed, such as if you're about to apply for a mortgage.
What happens if you never pay collections? ›
If you don't pay, the collection agency can sue you to try to collect the debt. If successful, the court may grant them the authority to garnish your wages or bank account or place a lien on your property. You can defend yourself in a debt collection lawsuit or file bankruptcy to stop collection actions.
What will disqualify you from an FHA loan? ›
The three primary factors that can disqualify you from getting an FHA loan are a high debt-to-income ratio, poor credit, or lack of funds to cover the required down payment, monthly mortgage payments or closing costs.
Collection accounts may affect your credit scores and may stay on your credit reports for up to seven years. Paying off collection accounts can have a lot of benefits, including potentially improving some of your credit scores.
Can I get a USDA loan with collections on my credit? ›
Generally, you must have no late payments or collections in your credit history within 12 months prior to your application for a USDA loan.
What credit score is needed to buy a house? ›
The minimum credit score needed for most mortgages is typically around 620. However, government-backed mortgages like Federal Housing Administration (FHA) loans typically have lower credit requirements than conventional fixed-rate loans and adjustable-rate mortgages (ARMs).
Do collections go away after paying? ›
Like other adverse information, collections will remain on your credit report for 7 years. A paid collection account will remain on your credit report for 7 years as well. There is a state exception for residents of New York for which paid collections fall off their credit reports after 5 years.
How badly do collections hurt your credit? ›
A collection on a debt of less than $100 shouldn't affect your score at all, but anything over $100 could cause a big drop. In many cases, it doesn't even matter how much it is if it's over $100. Whether you owe $500 or $150,000, you may see a credit score drop of 100 points or more, depending on where you started.
Should you get out of debt before buying a house? ›
If you have a substantial amount of high-interest debt, consider paying it down before saving for a house. Any interest – but especially high-interest debt – can significantly extend your debt repayment timeline and eat away at the money you could be saving for a home.
Will my credit score go up if I pay off collections? ›
For some credit scoring models, paying off collection accounts may improve credit scores. FICO® Score 9, FICO Score 10, VantageScore® 3.0 and VantageScore 4.0 credit scoring models penalize unpaid collection accounts. Paying off collection accounts may help improve these scores.
What debt is considered when buying a home? ›
Back-end ratio
The back-end DTI includes all your monthly debt payments — such as credit cards, student loans, personal loans and car loans — in addition to the mortgage payment. Back-end ratios tend to be higher, since they take into account all of your monthly debt obligations.
