Because buying a home is a big (and exciting!) investment, many people have questions about the finance part of the process. A common question we hear is, "Can I buy a home if I have collections on my credit report?" Fortunately, the answer is yes. But it depends how much money you owe and what type of debt it is.
Here are some things you should know if you have collections but want to buy a home.
The Good News: Your Situation Doesn’t Have to be Perfect.
Mortgage lenders expect you to have some debt. To them, it's more important to know what type of debt you have and how much. They also want to know if you have any “derogatory credit.”
Derogatory credit includes, among other types, “collections” and “charge-offs:”
- Collections are unpaid debts forwarded to a lender’s collections department or an outside agency. Collections show on your credit report, and outstanding collections will raise concerns for lenders.
- Charge-offs are debts that cannot be collected and are written off by the lender. Any debt overdue (120 days for loans, 180 days for credit card debt) must be written off. Bankruptcy debt is also written off.
Charged-off debt is not forgiven and will show up on your credit report for seven years. Lenders may also sell charge-offs to collection agencies who may try to collect the debt until the statute of limitations runs out in your state.
The Great News: Help is Out There
Don’t worry! There are professionals out there who can help you get a grasp on what you have, what you owe, and what you can afford. For instance, Twin Cities Habitat for Humanity financial coaches can help you build a budget, set up payments for your collections, and increase your credit score.
Look for the Exceptions
All lenders have a limit for the amount of money in collections they allow a borrower to have. Traditional lenders may not work with a borrower who has any collections on their credit report. But there are exceptions.
A lender may ask a borrower to prove that a certain amount in collections has already been paid or prove that a repayment plan was created. Other lenders may be more flexible. For example, TCHFH Lending, Inc.’s mortgage allows a client to have up to $1,000 in collections or up to $3,000 in medical collections and still be eligible for the loan.
Know Your Ratios
Lenders look at your credit report to see what significant monthly debts you have including collections and charge-offs. Using these figures, they calculate your debt-to-income ratio (DTI). Your debt-to-income ratio allows the lender to evaluate how much you can afford to borrow considering the payments you need to make toward collections. Most lenders want a borrower to have a DTI below 43%.
With exceptions, your lender may require you to pay off any collections and charge-offs on your credit report. Even if your DTI is within a healthy range, the loan officer may indicate collection items are delaying loan approval.
Regardless of what a lender requires, start now to strengthen your financial situation. Pull a free credit report as soon as you think about buying a home. This will help you understand where you are financially and give you time to create a plan to improve your finances if you need to.