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.
But the reporting of these derogatory accounts doesn’t disqualify you from getting a mortgage. You are still eligible for a conventional loan with charge-offs, collections, and judgments.
Here's how to deal with each of these types of accounts to meet conventional lending requirements.
Highlights
- You can still qualify for a conventional loan with charge-offs, collections, or late payments, but some debts must be resolved before closing.
- Late mortgage payments or a past-due mortgage within the last 12 months disqualify you from a new conventional loan.
- Charge-offs and collections may not need to be paid for single-unit primary residences but may require payment for second homes or investment properties.
- Medical debts are excluded from conventional loan credit requirements.
- Manually underwritten loans have stricter guidelines, often requiring debts over $250 to be paid off.
Late Payments on Past-Due Accounts
First and foremost, all past-due debts must be brought current. These are accounts where payment is late, generally by up to a few months, but the debt has not yet been written off or turned over for collection.
While it's a good idea in any case, conventional lenders will require you to pay the arrears on past-due accounts before closing.
Past Due Mortgages
Past-due account rules do not apply to home loans that are behind in payments. If you have an existing mortgage that is 60 days or more past due, you are ineligible for a new conventional loan. Unlike other late payments, you cannot bring a past-due mortgage current to restore your eligibility.
Conventional lending guidelines also disqualify borrowers with mortgages reported as past due by 60 days or more within the previous 12 months.
Collections and Charge-Offs (Non-Mortgage)
When creditors consider a debt uncollectable, they typically write it off their balance sheet. This is called a charge-off and gets reported on your credit. Debts that are charged off are generally sold to collection companies and can also appear on your credit report in that manner.
Unlike past-due accounts, debts that are in collections or have been charged off do not always need to be paid for you to be eligible for a conventional loan. Your responsibility to qualify for funding depends on the type of property you're financing.
Notice About Medical Debts: Medical debts are excluded from these rules and are not required to be paid off before funding, regardless of property type.
Single-Unit Primary Residences
If you’re purchasing or refinancing your single-unit primary residence, you won't need to pay off any charge-offs or accounts in collections to qualify for a conventional loan.
For example:
A first-time homeowner is buying a condo as their primary residence. They have three credit card accounts in collections with balances of $4,000, $6,500, and $9,300. In this case, the borrower would not have to do anything to be eligible for a conventional loan.
Second Homes and Multi-Unit Primary Residences
With a second home or primary residence with 2-4 units, you will be required to pay any debt that’s been charged off or put into collections in excess of $5,000. You won't need to pay anything if your cumulative collections and charge-offs are below this amount.
For example:
An existing homeowner wants to invest in real estate by purchasing a triplex and living in one of the units full-time. They had a vehicle repossessed last year, and the lender charged off the $4,000 deficiency balance. They also have a credit card in collections for $1,400. Here, the borrower would need to pay off the credit card debt to bring their total below $5,000.
Investment Properties
If you're applying for a conventional loan on an investment property, you must pay any reported charge-offs or collections equal to or greater than $250. You must also satisfy accounts that bring your total obligations above $1,000.
For example:
A property owner wants to purchase, renovate, and rent out the home next door to their primary residence. They have an emergency room bill in collections for $2,300. They also have an old cellphone account in collections for $225. In this situation, the borrower would not have to do anything to qualify as medical debts are exempt, and the cellphone account is below the $250 threshold.
Guidelines for Manually Underwritten Conventional Loans
In most cases, conventional loan applications that require manual underwriting will have more stringent guidelines for satisfying debt that's been charged off or put into collections. If you don't meet the requirements for automatic (computerized) underwriting, you must pay off any accounts of $250 and above. You also must satisfy any charge-offs or collections over a cumulative total of $1,000.
This applies to all manually underwritten loans, regardless of the property type. As usual, medical debts are excluded from these requirements.
Mortgages Which Have Been Charged Off
Lenders consider the mortgage charge-off to be a significant credit event on par with bankruptcy. Unlike other charge-offs on your credit report, if you’ve had a previous mortgage written off, you must wait four years to qualify for a conventional loan.
The waiting period may be reduced to two years in situations where a mortgage charge-off resulted from extenuating circumstances, including divorce, job loss, and medical debts.
Recorded Judgments and Liens
If you have any recorded liens or open court-ordered judgments against you, you will be required to pay them off in full before closing the loan. This includes delinquent federal taxes if you've had a Notice of Federal Tax Lien filed against you in the same county as the property you're financing.
Sizable judgments and liens can drain a borrower’s funds to close. If available cash drops below the required amount, the borrower may become ineligible. This is especially true for purchase transactions, where the buyer needs to pay for the down payment and closing costs.
The burden can be less when refinancing an existing property. However, you'll still need funds left over to cover conventional loan closing costs, which average 2% to 5% of the principal amount. Many homeowners with a judgment or lien against them use a cash-out refinance to pay off their outstanding obligations as part of the funding process.
Disputing Incorrect Information on Your Credit Report
Clearing up any discrepancies on your credit report before applying can improve your chances of qualifying for a conventional loan. This often involves filing a dispute against incorrect information, including:
Accounts that aren’t yours/you aren’t responsible for
On-time payments reported as late
Incorrect balances
Derogatory marks older than seven years (in most cases)
However, this process takes time. Credit reporting companies have up to 45 days to investigate your dispute and another five days to update you on their findings. If you have disputed accounts on your credit report when you apply for a conventional loan, you may need to provide documentation to support your dispute.
Sometimes, a disputed account must be removed or corrected for you to qualify for a mortgage. In that event, you must prove that you aren't responsible for the debt or that the information is inaccurate or incomplete.
Applying for a Conventional Loan with Charge-Offs, Collections, and Judgments
If you're applying for a conventional loan with charge-offs, collections, and judgments, you may face a more complicated mortgage approval process. But getting a loan is still possible, especially if you’re working with a lender experienced in helping buyers with derogatory accounts on their credit reports.
Tim Lucas is the editor and Lead Analyst for MortgageResearch.com. Tim spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. He has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, and more.