Applying for a Federal Housing Administration (FHA) mortgage typically involves a substantial amount of time, paperwork and out of pocket costs. The FHA mortgage program, which is widely used by home buyers, has many different rules and regulations that can result in approval delays or a loan turn down.
One of the primary purposes of FHA Mortgagemag.com is to educate consumers about FHA mortgages prior to beginning the FHA mortgage loan process. Many borrowers applying for FHA financing wind up being turned down for a variety of reasons, as can be seen in the HUD FHA Single-Family Outlook Report. For the month of February 2012, the FHA received a total of 155,248 applications but wound up endorsing only 90,561 approved mortgages.
One area of concern for many potential FHA borrowers involves collection accounts, disputed credit accounts and judgments, all of which could lead to a loan turn down. In a recent Mortgagee Letter 2012-3, HUD issued new guidance to FHA underwriters regarding collection accounts, disputed accounts and judgments. The new guidelines will become effective July 1, 2012.
Here’s what you need to know.
Collection Accounts
Under the old rules, the FHA did not require that the borrower pay off collection accounts as a condition of mortgage approval. Under the new rules, outstanding collection accounts in excess of $1,000 must be “resolved” by the borrower.
Collection accounts can be resolved to the FHA’s satisfaction in a number of different ways, including paying off the accounts in full prior to or at closing, or entering into a payment agreement with the creditor. If the payment agreement route is taken, the FHA will require that a minimum of three months of verified payments be made in accordance with the payment arrangement prior to closing. Obviously, if a mortgage borrower chooses to start making monthly payments on a collection account, this could result in a 3 month delay of mortgage approval.
If the borrower has collection accounts with a total outstanding balance of less than $1,000, the borrower does not have to pay off the accounts as a condition of mortgage approval. If you owe slightly more than $1,000 in collection accounts, don’t even think about making a partial payment to bring the total balance below $1,000. The FHA specifically states that a partial pay down to reduce collection account balances below $1,000 is “not an acceptable resolution of accounts.”
The entire issue of collection accounts is just one of many reasons for reviewing your credit report prior to applying for an FHA mortgage. I have seen many examples of applicants who were genuinely shocked when they discovered that they had collection accounts on their credit reports. Often times this arises from co-payments due for medical services where the health provider routinely sends overdue accounts for co-payments to a collection agency without notification and the consumer does not find out about it until much later.
Disputed Accounts
Under the old rules, disputed accounts were referred to the FHA underwriter for review. The new rules regarding disputed accounts are now more formalized and allow less discretionary decision making by the underwriter.
Under the new rules, if the automated underwriting system approves an FHA mortgage applicant who has disputed accounts, no underwriting review is necessary. The FHA will effectively ignore disputed accounts if the total account balance is $1,000 or less and if the accounts are over 2 years old. The borrower effectively gets a “Get Out Of Jail Free” card for disputed accounts that are minor and several years old.
If the total amount of disputed credit accounts exceeds $1,000, the borrower has to rectify the situation by paying the accounts in full prior to or at closing or setting up a payment arrangement with the creditor. If monthly payment arrangements are used to settle the disputed accounts, the borrower must verify that at least three months of payments have been made on time
If the disputed account arose due to identity theft, the borrower must provide documentation proving that the amount claimed as due is fraudulent.
Note: Due to vociferous objections to the new FHA rules on disputed accounts by mortgage industry lobbyists, the FHA announced that they would seek “additional input” on the issue and clarify the new guidelines in Mortgagee Letter 2012-3 prior to the implementation date of July 1, 2012.
Judgments
The FHA guidelines offer little latitude with court ordered judgments. When a creditor receives a judgment, that means the creditor took you to court and won the case. The judgment becomes a matter of public record and has a major negative impact on your credit scores. The FHA requires that all court ordered judgments be paid off before a borrower can be eligible for FHA financing.
The FHA allows an exception for a borrower to be approved with an outstanding judgment balance only if a payment arrangement with the creditor has been established and three monthly payments can be verified. The monthly payment on the judgment must also be included on the borrowers list of creditors and included in the calculation of the applicant’s debt to income ratio.