FHA loans are known for their level of forgiveness, giving people with less than perfect credit the opportunity to become a homeowner. This does not mean that lenders forgive everyone, though. You have to have adequate reasons for certain negative events on your credit report, especially collections. Just having a collection or two on your credit report does not disqualify you for the loan, but it does put you in a different category when it comes to verifications. You will have to undergo a bit more stringent application process in order to determine the reason for the collections. Here are the three ways that lenders look at collections.
Negligence on the Part of the Borrower
The first way lenders look at a collection is negligence on the part of the borrower. That is the most common view of this debt. If someone has an account that went unpaid long enough that it had to go into collections, the lender can only assume that the borrower just did not pay his bills because of irresponsibility. This will not bode well if you want to apply for an FHA loan, unfortunately. The good news is that you can prove that negligence was not the reason, which we will get into in the next two sections. Let’s take a look at an example of negligence:
- Bill has a medical bill that went into collections. It was for an x-ray for the time he thought he broke his arm. He did not pay the bill, but at the time he was working full-time and had very few bills to pay. He does not have any reason to show that he was incapable of paying the bill, so the lender has to assume that Bill was just being negligent and did not pay what he owed. Bill is now considered a high risk and will have a harder time getting an FHA loan.
Not Budgeting Correctly
Not budgeting correctly is different than just being negligent. If you are deemed as being negligent, it means that you purposely did not pay your bills, like the above example, for reasons unknown. Bill does not have to disclose why he chose not to pay his x-ray bill, but he will pay for it by not being able to get FHA financing unless he makes good on that collection. Now, on the other hand, if Bill was able to prove that he just did not budget correctly, there might be some leeway in his ability to get approved for FHA loans. Let’s take a look:
- This time it is the same collection bill – for an x-ray, but Bill can show that he wanted to pay the bill and made efforts to make good on it, but he did not properly handle his finances. If he can prove in writing that he talked with the hospital and asked for a payment plan or some type of workout for the outstanding balance, he can show that he made an attempt. No debtor has to automatically approve your need to work something out for an outstanding debt. If Bill can show that his money went to other bills and was not just blown on other things or that he did not just completely overlook the need to take care of this debt, he might be able to be granted an exception by a willing FHA lender.
The most common way to get collections overlooked and to get approval on FHA loans is with extenuating circumstances. This is not something you can make up; it has to be a real situation. For example, let’s say you lost your job because your position was eliminated and the company is downsizing. This is not something you consciously did to make you lose your job and you did not improperly balance your finances – you were simply put out of a job without realizing what was going to happen. If your income was cut by more than 20 percent because of the occurrence, you could be considered an extenuating circumstance. What the lender wants to see after the fact, is that you were able to pick up the pieces and move on. They want to see that you were able to get a new job and bring your income back up to the level it was at before. Basically, they want to see financial responsibility after undergoing a hardship.
- In the Bill example, FHA lenders might be willing to either overlook Bill’s medical debt or at the very least, help him figure out how to get it paid off so that they could close on his FHA loan. This situation does not show that Bill was irresponsible like either of the above two examples; he was simply a victim of unforeseen circumstances and luckily, the FHA is great about giving second chances.
The good news is that FHA loans are not automatically out of the realm of possibility for you if you have collections on your credit report. You should be ready to pay them off in order to get approved, as that is the case for most collections. But, if a lender is willing to give you a mortgage even after you have collections reporting, you should feel fortunate enough to figure out a way to get those collections paid. Then you have a clean slate to work with and will raise your credit score in the meantime. It always pays to talk to several lenders regarding your exact situation in order to determine what your chances are of getting an FHA loan. Remember that even though one lender might deny you, another lender might be willing to give you a chance, especially since the FHA backs up the loans, giving the lender less risk than they would have with any other program. Shop around with different lenders, discussing your circumstances with collections to see who will be willing to work with you on your quest to become a homeowner.