New FHA Collections Rule Limits Borrower Eligibility

June 2012Articles In the Zone

In a February 28, 2012 Mortgagee Letter, the U.S. Department of Housing and Urban Development (HUD) announced guidance changes affecting lending eligibility requirements for borrowers with disputed accounts or accounts in collection. The new requirements ban Federal Housing Administration (FHA)-insured loans to borrowers who have $1,000 or more in collections.

The old guidance required that if the borrower’s credit report revealed disputes of any credit accounts or public records, the mortgage application must be referred to an underwriter for review.

Under the new guidance, mortgage applications will no longer be referred to an underwriter due to disputed account as long: (1) the total outstanding balance of all disputed credit accounts or collections are less than $1,000; and (2) disputed credit accounts or collections are aged two years from date of last activity.

However, if the borrower has individual or multiple disputed credit accounts or collections with singular or cumulative balances equal to or greater than $1,000, the accounts must first be resolved by establishing payment arrangements with a minimum of three months of verified payments, or paying off the account in full prior to, or at, the time of closing. Paying down of balances on the accounts to reduce the balance below $1,000 is not deemed an acceptable resolution.

FHA continues to require judgments to be paid off before the mortgage loan is eligible for FHA insurance.

If the collection accounts can be traced back to so-called “life events,” such as medical issues or divorces, the borrower may qualify for an exemption from the rule.

Analysts have estimated that once the rule goes into effect it will adversely impact between 30 to 40 percent of first-time homebuyers. Homebuilders whose portfolio is geared toward young, first-time homebuyers will likely experience constraints in qualifying purchasers for FHA-insured loans.

The new guidelines were set to go into effect on April 1, 2012, but have been postponed until July 1, 2012.