No. A collection account, an old debt that a creditor has handed to a collection agency, doesn't stop a mortgage on its own. Each loan program has a written rule for collections, and on most of them the buyer still gets approved, sometimes without paying a dime toward the collection.
How each program treats collections
| Program | Non-medical collections | Medical collections |
|---|---|---|
| FHA | Under $2,000 combined: no action needed with an automated approval. $2,000 or more: pay in full, set up a payment plan, or count 5% of the balance as a monthly debt | Left out of the $2,000 total |
| Conventional (Fannie Mae) | One-unit home you live in: no payoff required at any amount. 2 to 4 units: more than $5,000 combined must be paid at or before closing | Left out of the limits |
| VA | No payoff required; the underwriter weighs the overall credit pattern | No payoff required |
| USDA | Over $2,000 combined: pay in full, payment plan, or 5% of the balance counted monthly | No payoff required |
FHA's rule comes from HUD Handbook 4000.1. The $2,000 is cumulative, meaning it adds up every non-medical collection for everyone on the loan. A payment plan has to be documented by the creditor, and its monthly payment goes into your debt-to-income ratio, the share of gross monthly income that goes to debt payments.
Charge-offs, accounts the original creditor wrote off as a loss, don't have to be paid for FHA, VA or USDA, or for a Conventional loan on a one-unit home you live in. Judgments are different. On FHA, a court judgment has to be paid off by closing, or be on a written payment agreement with three months of on-time payments already made.
A worked example with $3,400 in collections
A buyer earns $4,800 a month and pays $450 on a car and $150 in card minimums, $600 in all. Two non-medical collections sit on the report: $2,200 from an old apartment and $1,200 from a cell phone account. Together that's $3,400, over FHA's $2,000 line.
With no payment plan in place, the lender adds 5% of $3,400 as a monthly debt, which is $170. FHA's 56.9% total ratio allows $2,731.20 of debt payments on $4,800 of income. After $600 of existing payments and $170 for the collections, the house payment can be up to $1,961.20.
Now pay off only the $2,200 account. The $1,200 left is under $2,000, so FHA sets it aside and the $170 disappears. The house payment can rise to $2,131.20, still under the 46.9% housing limit of $2,251.20.
| Collections counted | $2,200 account paid | |
|---|---|---|
| Maximum house payment | $1,961.20 | $2,131.20 |
| Approximate price with FHA at 3.5% down | $251,000 | $276,000 |
Those prices use a 5.75% rate on a 30-year fixed, taxes at 0.85% and insurance at $230 a month. Paying $2,200 adds about $25,000 of buying power. Paying the $1,200 account instead would leave $2,200 outstanding, still over the line, and change nothing, so the choice of which account to pay matters.
Before you pay a collector
Paying an old collection doesn't erase it from your credit report, and it rarely lifts a score much on the Classic FICO models mortgage lenders pull. The reason to pay one is to meet a program rule or to free up room in your ratios, and plenty of buyers need neither.
- Ask for a settlement. Collection agencies often accept less than the full balance. Get the agreement in writing before you pay.
- Put any payment plan in writing. FHA and USDA count the monthly payment, and the lender needs the creditor's letter showing it.
- Hold disputes until after closing. FHA's automated approval is downgraded to a manual review when disputed non-medical derogatory accounts total $1,000 or more, so a dispute filed mid-loan can slow things down.
- Mention judgments and tax debts early. They follow their own rules and take longer to clear.
Put your income, your debts and 5% of any collections over $2,000 into the DTI calculator to see your ratios. Before you send a collector a dollar, call AAA Capital Funding at 888-601-8344 and we'll tell you which account, if any, is worth paying.