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? ›
Securing a mortgage doesn't always require perfect credit history. It doesn't even require you to be completely debt-free. If you have collections on your credit report, you can still get a mortgage approval, depending on your lender, the kind of debt you have, and the mortgage you're applying for.
Should I pay off collections before applying for a mortgage? ›
Do you have to pay collections to get a mortgage? That depends. If you can show that a debt is uncollectable due to the statute of limitations, you probably won't have to pay it. But if you do owe the money and it's collectible, you should pay it or establish a payment plan before applying for a loan.
Can I get an FHA loan with collections on my credit report? ›
The FHA does not require collections to be paid off entirely in order for a borrower to be approved. However, they do recognize that collections can impact a borrower's ability to repay their loan, which is something they take into consideration.
Can I have debt and still buy a house? ›
Yes, you can buy a house even if you have bad credit. Low-credit home loan options are also offered by Fannie Mae and Freddie Mac, the FHA and the U.S. Department of Veterans Affairs (VA). However, trying to buy a house with bad credit is slightly different than buying while carrying credit card debt.
Does collections affect getting a house? ›
The amount owed in collections can also impact a borrower's mortgage application. Larger amounts may signify greater risk to lenders. If possible, borrowers should consider paying off or negotiating these amounts down, so they can show lenders that they're taking meaningful steps to resolve the issue.
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 be completely debt free before buying a house? ›
You don't need to be completely clear of debt to be in good standing for a mortgage, in fact some debt can be good. If you're looking to get approved for a mortgage, you should be aware of the good and bad kinds of debt you currently have.
How much debt is acceptable when applying for a mortgage? ›
Most borrowers need a DTI of 43% or less to qualify for an FHA loan. In some extenuating circ*mstances, such as a buyer with a large down payment or significant income, the DTI ratio for an approved FHA loan may be higher.
How much will credit score increase after paying off collections? ›
VantageScore® 3.0 and 4.0, the most recent versions of scoring software from the national credit bureaus' joint score-development venture, ignore all paid collections and all medical collections, whether paid or unpaid. As a result, those accounts will not affect your VantageScore.
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.
Should I pay off an old collection? ›
Paying a collection account won't immediately heal your credit but can offer other benefits. You may want to pay off a collection account to: Avoid a lawsuit. The debt collector could sue you for the money you owe if your debt hasn't passed the statute of limitations.
Does FHA require collections to be paid off? ›
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.
How much debt is too much to buy a house? ›
Generally speaking, a good debt-to-income ratio is anything less than or equal to 36%. Meanwhile, any ratio above 43% is considered too high. The biggest piece of your DTI ratio pie is bound to be your monthly mortgage payment.
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 is the 5% rule for FHA collections? ›
FHA Collection Guidelines
If a payment arrangement is not available, 5% of the outstanding balance will be used with the debt-to-income calculation. If the debt has been paid in full, the debt will need to be verified that it was satisfied. The debt can be paid at closing with a payoff.
Do all collections affect credit score? ›
Collections reported with an original amount under $100 are disregarded by FICO® Score 8, FICO® Score 9 and the FICO® Score 10 suite. Unpaid medical collections >$500 are considered, but have less impact on the score within FICO Score 9 and the FICO Score 10 Suite compared to older FICO Score versions.
Does FHA require past due accounts to be brought current? ›
the delinquent account is brought current, paid, or otherwise satisfied, or a satisfactory repayment plan is established between the borrower and the Federal agency owed, which is verified in writing. Tax liens may remain unpaid provided the lien holder subordinates the tax lien to the FHA-insured mortgage.
Should I pay loans that are in collections? ›
While paying off your debt in full likely won't may not improve your score by much, it will show lenders that you are more creditworthy. Pay a settled amount: Some collection agencies will give you a deal if you agree to pay a lump sum. (After all, these companies want their money, so they'll take what they can get.)
