If you are thinking about buying a home but have a checkered credit history, you might be wondering how any collections can affect your chances of obtaining a mortgage.
Many aspiring homeowners find themselves asking this same question, and while there are no easy answers, there are several factors to consider before you start your home search.
Learning about these and steps you can take before submitting your mortgage application can help save you from mistakes that can cost you the home of your dreams.
Will a Collections Account Affect My Mortgage Application?
Whether or not a collections account negatively affects your chance to obtain a mortgage depends on the size of the account, how old it is, and your subsequent credit history.
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The Impact of Collections on Your Credit Report
Secured or unsecured debts that are 180 days delinquent or more eventually are sold by your creditor to a collections agency. This shows up as a derogatory even on your credit history and can significantly drop your score, depending on how high it was prior to your account entering collections.
An account that has been sent to credit collections can present a long-term drag on your credit score. However, many mortgage lenders will disregard medical debts that have entered collections. This is because these debts often arise after a dispute with an insurance company and are not reliable proxies for a borrower’s creditworthiness.
How Your Credit Score Affects Buying a Home
Your credit score is a key factor that lenders use to decide whether to work with you or not. With a higher credit score, you may be able to obtain a larger mortgage at a lower interest rate than someone with a relatively low credit score. Generally speaking, buyers with a credit score of 740 and over will have a much easier time getting approved for a mortgage.
In most cases, lenders won’t work with buyers who have a credit score lower than 620. FHA loans require borrowers to have a minimum credit score of 500 to qualify for approval.
How to Remove a Collections Account
In the case of legitimate collections accounts, the only way to remove them from our credit history is to pay them off and wait. It can take seven years for a collections account to fall from your record, but in a little as 12 months it can stop lowering your credit score.
To remove illegitimate collections accounts, file a complaint with the credit bureau reporting it, which can then remove it from your record.
Should I Pay Off Debt Before Buying a Home?
It’s tempting to pay off a collections account if you are buying a home, but doing so can actually reduce your chances of obtaining a mortgage.
Once you pay off an account, it will be displayed as “Current” on your credit report. This counts as “Recent Activity,” which can lower your credit score and may cause your application for a mortgage to be rejected. It’s best to ask your lender what to do if you have accounts in collection.
Buying a home while you have accounts in collection can be a challenge, but if you have a relatively high credit score and coordinate with your lender before taking closing any accounts, you can still realize your dream of home ownership.
