Handling of Collections & Disputed Accounts
In an effort to reduce risk in backing mortgage loans, HUD has once again revised its regulations, effective October 15.
Mortgage Letter 2013-24 deals with credit analysis of collections and judgments, and outlines how lenders must proceed.
As you probably know, the first step in FHA loan approval is use of the TOTAL Mortgage Scorecard. This scorecard takes into account the presence of collections or judgments via the credit score. Should a borrower be approved through the TOTAL Mortgage Scorecard, no documentation or letters of explanations will be required.
If TOTAL Mortgage Scorecard results in a “Refer,” the lender must manually underwrite the loan – and must determine the cause of the collections or judgments.
- Was it disregard for financial obligations?
- Was it an inability to manage debt?
- Were there extenuating circumstances?
In order to make this determination, the lender must gather supporting documentation, including a letter of explanation from the borrower for each outstanding collection account and/or judgment. It will be up to the lender to determine whether the explanation is consistent with other credit information in the file.
If the borrower’s combined collection accounts equal $2,000 or more, the lender must perform a “Capacity Analysis.” Medical collections and charge-offs are not included in this aggregate. However, collection accounts of a non-purchasing spouse ARE included here in Texas.
Capacity analysis consists of one of the following:
- Payment in full of the collection account – using a verified acceptable source of funds.
- A payment agreement with the creditor, accompanied by a letter from the creditor verifying the monthly payment. This monthly payment will be included in the borrower’s debt to income ratio.
- In the absence of a payment arrangement, the lender must calculate a monthly payment equal to 5% of the outstanding balance. This payment will be included in the borrower’s debt to income ratio.
Until now, borrowers were required to pay off court ordered judgments before being eligible for FHA insurance. Now there is an exception.
Under the new regulations a loan may be approved if the borrower has entered into an agreement with the creditor to make regular monthly payments and has made a minimum of three such payments over a period of 3 or more months. Pre-payments will bring the balance down, but won’t help with loan approval.
The borrower must provide evidence that the payments have been made on time and in accordance with the agreement.
And of course, the payment will be included when calculating the borrower’s debt to income ratio.
As with collections, in Texas and other community property states judgments against a non-purchasing spouse also must be paid off or meet the rules for exception.
Many borrowers have found to their dismay that their credit reports contain inaccurate information. Some of that inaccurate information is the result of poor data entry, some is there because old accounts that should have “fallen off” the report have not been removed, some because the original bill was in dispute, and some are due to identity theft.
Accounts that appear as “in dispute” on a borrower’s credit report are not considered by TOTAL Mortgage Scorecard. Therefore, they must be addressed in manual underwriting.
Disputed accounts fall into two categories: Derogatory and Non-derogatory.
Non-derogatory disputed accounts
If a borrower is disputing non-derogatory accounts, the lender is not required to downgrade the application to “refer.” However, if the dispute results in the borrower’s monthly debt payments being lower than originally indicated, he or she must provide documentation.
Derogatory Disputed Accounts
If the cumulative outstanding balance of such accounts is less than $1,000, a downgrade is not required.
If the cumulative outstanding balance is $1,000 or more (excluding medical accounts) the borrower must provide a letter of explanation and documentation supporting the basis for the dispute. The lender must analyze the documentation to determine whether the account should be considered in the underwriting analysis.
In contrast to collections and judgments, disputes involving a non-purchasing spouse are not included in the $1,000 aggregate balance.
Disputed accounts resulting from identity theft and credit card theft are not included. However, the borrower must provide documentation verifying the charges as fraudulent. This can include a letter from the creditor and/or a police report.
Texas Mortgage Banker