The Federal Housing Administration (FHA) recently announced a policy change in how they will treat mortgage loan applications for those whose credit histories contain unpaid collection accounts. The changes will prevent individuals with outstanding unpaid collection account balances—whether from credit cards, medical bills or other debts when the combined outstanding balances total $1,000.00 or more—from getting a mortgage. For those who haven’t been able to keep bills paid up to date, this means that resolving past due accounts is becoming increasingly important. The rule was originally scheduled to go into effect April 1, but it has been delayed until July 1.
With the new rule, the bad debts have to be paid for several months or be fully resolved prior to closing an FHA home loan. If the debts are disputed as related to identity theft or unauthorized use of an account, or if collection items total less than $1,000 and are a minimum of two years old, the new rule may be waived. If your personal financial hardship was the result of a death, job loss, or divorce you may be able to document the issues to the lender in support of a waiver, according to a policy clarification issued by the FHA.
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This new rule should not surprise anyone paying attention to the mortgage market. Loose mortgage loan underwriting standards were one of the contributing factors that led to the implosion of the housing market. A tightening up on loan approval and quality standards is certainly a rational response. The result is, however, that the new FHA policy treatment will likely prevent more would-be home buyers from qualifying for an FHA loan, which is often a better priced loan product, especially for first time home buyers.
While this change in rules is designed to improve mortgage loan quality, some have estimated that this new policy will lock a good 35% of people in certain hard hit local economies out of the home-buying market. This can easily be the case when, as reported earlier this year, data from 2011 showed that roughly 1 in 7 Americans are dealing with collections related to one or more bills they were unable to pay on time. Also consider that over 250 billion dollars of student loan debt is currently in default. According to Fitch Ratings: “as many as 27% of all student loan borrowers are more than 30 days past due.”
Depending on how hard someone is hit with financial setbacks, and how long it takes to pick yourself up and dust off the debt, you eventually must make progress and improvements to your credit reports.
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Here are three options to consider for dealing with bad debts:
- One year participation in a debt management plan traditionally offered by Consumer Credit Counseling Services is a minimum standard used by the FHA to show that you are serious about resolving your financial obligations.
- Negotiating and settling old balances for less than what is owed as satisfaction of the debt and fully documenting each transaction may provide a more rapid and less costly method for resolving collection entries on your credit report. Be sure to fully document each settlement in case your credit reports are not properly updated.
- Filing for chapter 7 bankruptcy where your unsecured debts are typically discharged can provide the type of financial fresh start you need. Just know that to qualify for an FHA loan (as well as others), your bankruptcy must be discharged for at least two years.
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Image: David Sawyer, via Flickr.com