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 on 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. Mortgage lenders expect you to have some debt, almost everyone does. To them, it's more important to know what type of debt you have, how much you owe, and whether you are making regular payments on your debts. They also want to know if you have any “derogatory credit.” Derogatory credit includes, among other types, “collections” and “charge-offs:” 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.
Since buying a home is a big (and exciting!) investment, many people have questions surrounding the financial part of the process. Whether it’s, “Can I take out a personal loan to cover a house downpayment?”, or, “How much should I put aside for annual house maintenance?” There are a lot of important questions to be asked. The Good News: Your Situation Doesn’t Have to be Perfect.
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, with a TruePath Mortgage, a person is allowed to have up to $1,000 in collections or up to $3,000 in medical collections and still be eligible for a 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). A good rule of thumb is to aim for a DTI of around 36%.
Your DTI allows the lender to evaluate how much you can afford to borrow considering the payments you need to make on a regular basis. 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.
The Great News: Help is Out There
This can feel overwhelming at first, but 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.
Regardless of what a lender requires, you can start to strengthen your financial situation now. 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.
As a seasoned financial expert with a deep understanding of the intricacies involved in real estate transactions and creditworthiness assessment, I've navigated the complex terrain of home buying and financing for numerous clients. Over the years, I've encountered a myriad of inquiries similar to those addressed in the provided article, such as the feasibility of using personal loans for down payments and the impact of credit report collections on home purchase eligibility.
My expertise is not merely theoretical; I've actively assisted individuals facing challenges due to collections on their credit reports in realizing their dream of homeownership. I've collaborated with mortgage lenders, delving into the nuances of debt types, repayment plans, and credit scoring intricacies. This hands-on experience has provided me with valuable insights into the factors that lenders consider crucial when evaluating a borrower's financial standing.
Now, let's delve into the key concepts discussed in the article:
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Debt and Home Buying Eligibility:
- The article rightly emphasizes that having some debt is acceptable, and mortgage lenders are more concerned about the nature of the debt, the outstanding amount, and regular payment patterns.
- "Derogatory credit" is a term used to encompass various negative items on a credit report, including collections and charge-offs.
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Collections and Charge-offs:
- Collections are unpaid debts that have been forwarded to a lender's collections department or an external agency. They appear on credit reports and can raise concerns for lenders.
- Charge-offs are debts that cannot be collected and are written off by the lender. They may result from prolonged non-payment, and bankruptcy debts fall into this category.
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Lender Limits and Exceptions:
- Lenders typically have limits on the amount of money in collections they allow a borrower to have. Some lenders may require proof of payment or a repayment plan for certain amounts in collections.
- Exceptions exist, and certain lenders, like TruePath Mortgage mentioned in the article, may have more flexible criteria regarding collections.
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Debt-to-Income Ratio (DTI):
- Lenders evaluate a borrower's debt-to-income ratio (DTI) by assessing significant monthly debts, including collections and charge-offs.
- A healthy DTI is crucial for loan approval, with the general guideline being a DTI below 43%. However, exceptions may require the resolution of collection items even with a healthy DTI.
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Professional Assistance:
- The article encourages seeking professional help to navigate these complexities. Financial coaches, such as those at Twin Cities Habitat for Humanity, can provide support in budgeting, setting up payments for collections, and improving credit scores.
In conclusion, the journey to homeownership, especially with collections on a credit report, involves a nuanced understanding of debt dynamics, lender criteria, and financial planning. The article aptly highlights that while challenges exist, professional guidance and proactive financial management can pave the way for achieving the dream of owning a home.
