A little-noticed mortgage rule change that took effect April 1 could create hassles for significant numbers of homebuyers who plan to use low down-payment Federal Housing Administration financing this spring.
The change affects anyone with one or more “collection” accounts buried away in national credit bureau files. These include medical, student loan, retail and other debts reported as unpaid — correctly or incorrectly — by creditors and subsequently sent to collection agencies.
In a reversal of its previous policy, the Federal Housing Administration says it will no longer approve applications where the borrowers have outstanding collections or disputed accounts with an aggregate of $1,000 or more of unpaid bills. Previously the agency took a more lenient approach, allowing lenders to review borrowers’ overall credit situation and approve applications despite the presence of such accounts.
Under its new rule, when collection items total $1,000 or more, the accounts will need to be paid off over a period of several months or be paid in full at or before the closing. In cases where the collections or disputed debts are attributable to identity theft, credit-card theft or unauthorized use of the applicant’s credit — or when collection accounts total less than $1,000 and are at least two years old — the new rule may be waived. Borrowers who have encountered “life events” such as death, divorce or loss of employment may also provide documentation to their lenders to support a waiver, according to a policy clarification issued by the agency.
The policy shift, which the agency says is part of its ongoing efforts to reduce loan defaults and insurance claims, has upset some mortgage lenders who specialize in FHA business. Clem Ziroli, president of First Mortgage in Covina, Calif., estimates that under the new standard, “35 percent of borrowers who’ve obtained FHA financing historically [would be] ineligible.” He complained in an email that “FHA’s mission has always been to serve low- to moderate-income borrowers” — a population segment where the presence of one or more collections on a credit report is not unusual.
Jeremy House, a loan officer with national mortgage firm Prime Lending in Tempe, Ariz., noted that there are vast numbers of consumers who have medical collection accounts outstanding in their credit files, sometimes long forgotten or dating back years, who will be hit hard by the policy change.
“I’m talking about people with solid incomes and high [credit] scores,” he said in an interview. He cited the example of an applicant with a FICO score of 770 who recently discovered that two new medical collections had popped up on his credit reports. The applicant said he had no knowledge of the unpaid bills or the doctor, and believes them to be in error. But the sudden appearance of the collection items knocked his FICO score down to 655. Under the new FHA policy, it could take months to dispute and resolve the issue at best.
Brad Yzermans, a loan officer with First Priority Financial in Temecula, Calif., said the heaviest impacts of the rule change will be in areas that have experienced high unemployment, negative equity and foreclosure problems over the past several years.
“I think this is a big deal,” he said in an interview. Large percentages of potential home purchasers — many of them minorities — inevitably have accumulated collection accounts as direct effects of local economic struggles. Yzermans said he’s already had to short-circuit the applications of three buyers who have open collections in their files but previously would have breezed through underwriting for an FHA loan. Worse, he added, there are buyers who are now somewhere in the pre-closing pipeline whose case files were not assigned numbers at FHA by the April 1 deadline. Those people may now be forced to postpone their plans — or even lose the house they wanted to purchase. Those people may now be forced to postpone their plans — or even lose the house they wanted to purchase.
Yzermans said that as a result of steadily rising insurance premiums and tightening of underwriting rules at FHA, “I’m starting to move my business more in the direction of conventional loans” — those eligible for purchase by Fannie Mae or Freddie Mac — where borrowers can obtain low down-payment financing using private mortgage insurance.
Bottom line: If you are considering applying for an FHA-insured mortgage to buy a house, be aware of the new policy. Well in advance of any loan application, order your credit reports from all three national bureaus — Equifax, Experian and TransUnion — or get them free at the bureaus’ jointly run online site, www.annualcreditreport.com. If you find outstanding collections that exceed $1,000, dispute them, negotiate them down, pay them off or otherwise make them disappear if you want to zip through the FHA underwriting minefield.
Kenneth Harney is a syndicated real estate columnist.