A collection account shows up when a bill goes unpaid long enough that the company hands it to a collection agency or sells it outright. The agency reports it as its own line on your credit report, separate from the original account. Old phone bills, utility balances, apartment move-out charges and medical bills are the usual sources. Most collections don't stop a mortgage, and FHA, Fannie Mae and USDA all leave medical collections out of their payoff rules.
FHA: the $2,000 line
HUD's handbook looks at the total of each borrower's non-medical collections. Below $2,000, nothing has to be done. At $2,000 or more, the lender picks one of three paths:
- Proof the collections are paid in full, at or before closing.
- A written payment arrangement with the collector, with that monthly payment counted in your debt-to-income ratio (DTI).
- With no arrangement, 5% of the outstanding balance counted as a monthly debt in DTI.
Medical collections and charge-offs don't go into that $2,000 total at all.
Conventional and USDA
Fannie Mae doesn't require a buyer of a one-unit home they'll live in to pay off collections, whatever the amount. On a 2 to 4 unit home you'll live in, collections and non-mortgage charge-offs totaling more than $5,000 have to be paid at or before closing. On an investment property, the limits drop to $250 per account and $1,000 in total. Medical collections are excluded from those limits.
USDA follows the same pattern as FHA: non-medical collections over $2,000 are paid, put on a documented plan, or counted at 5% of the balance.
A worked example
Tasha earns $5,000 a month and wants FHA. Her report shows $3,100 in medical collections and $2,600 across two non-medical collections.
- The $3,100 medical balance is ignored.
- The $2,600 non-medical total is over $2,000, so it needs one of the three paths.
- Counting 5% of it adds $130 a month to her debts ($2,600 × 5%). Against $5,000 of income, that's 2.6 percentage points of DTI ($130 ÷ $5,000).
- Each $100 of monthly debt costs roughly $14,000 of FHA buying power at a 5.75% rate, so $130 is worth about $18,000.
If Tasha's ratios have room, she can leave the collections open and still close. If $18,000 of price matters on the home she wants, paying them in full removes the $130 entirely, and a written plan with the collector at, say, $60 a month cuts the counted debt by more than half.
What you can do now
Pull all three credit reports and list each collection with its balance and whether it's medical. Dispute anything that isn't yours or is already paid. Before paying an old balance, ask us how it affects your score and your ratios, because the best order of payoffs depends on which program you're using.
Run your debts through the DTI calculator with and without the 5% figure to see the difference. Then call AAA Capital Funding at 888-601-8344 with your credit report in hand, and we'll tell you which collections matter for your purchase and which ones can stay.