How to Secure a Mortgage with Collections (2024)

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Published July 29, 2023 | Updated May 10, 2024

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Mortgage options for those with collections are limited, but they do exist. Learn more about how collections affect your ability to get a mortgage, what you can do about old collections, and top tips to help you secure a mortgage even with collections.

Can You Get a Mortgage with Collections on Your Credit Report?

The short answer is yes. Securing a mortgage doesn’t always require perfect credit history. It doesn’t even require you to be completely debt-free. If you have collections on your credit report, you can still get a mortgage approval, depending on your lender, the kind of debt you have, and the mortgage you’re applying for.

How Collections Affect Your Ability to Get a Mortgage

Knowing how collections affect getting a mortgage is the first step in understanding how to improve your chances of purchasing a home.

Debt-to-Income Ratio

All mortgage lenders look at yourdebt-to-income ratio when reviewing your application. This ratio helps mortgage lenders review how much income you have compared to the debt you’re carrying on a month-to-month basis.

This allows them to gauge your realistic ability to repay the loan when compared to the amount of debt you’re already carrying, so they can decide how much mortgage you can afford in both the good times and the rough ones. When you have accounts in collections recently, it likely means that your DTI ratio is too high, making it difficult to qualify for a mortgage.

The monthly debt payments that factor in the DTI ratio are your student loan payments, child support, credit card debt, car loans, and the mortgage if you were approved. Ideally, lenders prefer borrowers with aDTI ratio lower than 36%, but the highest is 43% to qualify for a mortgage.

Derogatory Credit

Mortgage lenders may also have restrictions on the amount ofderogatory credit they allow when determining eligibility. Lenders will naturally view derogatory credit as a negative–a “red flag,” if you will–and this can include charge-offs, bankruptcy, collection accounts, and late payments. Charge-offs and collections are usually not included in your DTI, especially if you are not making payments on them currently.

In most cases, you’ll, at a minimum, need to satisfy any pre-existing legal judgments and tax liens before you can get approval for a home loan. You can also set up a repayment plan for tax debt. You’ll need to pay off the tax lien before you can get approved for a conventional loan. If you’re applying for FHA loans, you may be approved if you set up a tax debt repayment plan and if the IRS lists the lien as secondary to the mortgage.

Factors That Lenders Consider When Evaluating Mortgage Applications with Collections

There are a lot of variables involved in evaluating a mortgage application. Underwriters have some discretion and the ability to present your application in the best possible light. Other than your credit history and score, here’s what lenders look for when considering a mortgage with collections.

Income and Debt

Your income is a major determining factor in how muchmortgage debt you can take on. But this is considered in relation to your other debts. The general guideline is that your mortgage payment should be about 30% of your gross income from all your income sources, and the maximum amount of this gross income you should pay towards your regular monthly debt payments combined is 40%. Your lender will take a full view of your application to determine the exact maximum figures in your unique situation.

Appraised Value

An important factor that lenders will consider is the appraised value of the property you plan on purchasing. The lending value for a home can be the appraised value or the purchase price, whichever is less.

Stability

Mortgage lenders also look at how long you have been at your job. Lenders prefer borrowers with a stable job history because it reassures them that they’ll have a reliable income to support their mortgage payments. It’s usually difficult to get a mortgage if you’re “on probation” when you’re starting work at a new job. If you’re considering a job change, it’s best not to do it shortly before attempting to secure a mortgage.

Down Payment

The larger the down payment, the better your chance of securing a mortgage withbad credit. You’ll very likely need to put down more than 5% if your mortgage application is not very strong. Lenders will also view where the funds for the down payment are coming from. Funds coming from family members are viewed less favorably than your own resources.

Tips for Improving Your Chances of Mortgage Approval with Collections

So, can you get a mortgage with recent collections on your credit report? You might not always qualify for the amount you want, but there are several things you can do to improve your chances of making your application more attractive to lenders.

Check Your Credit Report

Before you apply for a mortgage, get a free copy of your credit report from all three credit bureaus– TransUnion, Experian, and Equifax. Review each one in detail to see what lenders might find on it. Doing this can help you find errors and other items that you need to correct, as well as smaller debts you can easily pay off to improve your credit score.

Fix Any Mistakes

Not everything on your credit report may be accurate. Take a closer look to see if there are any inaccuracies, such as debts that have been discharged or already paid, incorrectly reported information, wrong information due to identity theft, wrong notations on closed accounts, and anything from an ex-spouse that shouldn’t be on your credit report.Credit repair can help you fix these errors and improve your credit score.

Improve Your Credit Score

Your credit score is the number that lenders will look at to determine your eligibility for a mortgage. Try to improve your credit score by paying your bills on time, keeping yourcredit card debt low, and reducing your existing debt. Avoid applying for or getting any new credit before you apply for a mortgage.

Lower Your DTI Ratio

Lenders will review your DTI ratio to determine how much mortgage you can afford. Aim to lower your DTI ratio to at least less than 43% but ideally lower than 36%. You can do this by either reducing your debt or increasing your monthly income. Review your expenses to see how you can reduce your recurring debt, such as credit card bills. Take up extra hours at your job or try to earn more income consistently each month through a side gig.

Put Down a Larger Payment

Save up a larger down payment to increase your chances of getting a mortgage with collections. This reduces yourloan-to-value ratio, which will make your application favorable. A larger down payment will also lower your mortgage amount, making your monthly payments more affordable. When putting down 20% or more on the house, you also won’t have to pay mortgage insurance (PMI).

What to Do with Debt in Collections

Most lenders will require you to resolve old collections before they approve your mortgage application. Depending on whether your collections are old or new, there are several things you can do.

New Collections

If you have new past-due accounts or collections, negotiate with your lender to come up with an arrangement that is suitable for you. Make sure to get it in writing before you start making payments. You should get the total amount to be paid, the number of payments, and the due dates in writing. You can also work with adebt relief company to negotiate a settlement on your behalf so you can get the most savings.

Old Collections

Paying off old collections on your credit reportmay not always improve your credit score. Older scoring methods don’t ignore paid collections, and many mortgage lenders still use this older credit scoring model. This means that even if you settle your account, you may not get a higher credit score after the account is updated on your credit report.

The only way paying off old collections can help your credit score is if the lender agrees to “pay for delete.” With this arrangement, the lender agrees to erase your account from the credit report in exchange for you paying off your debt. As credit reports age, collection accounts count less toward your score until they typically fall off after about seven (7) years. The best way to improve your credit score is by paying your debts on time and preventing any new derogatory information from being reported to your credit reports.

Check Local Statute of Limitations

Every state has different statutes of limitations, which usually last three to six years. This means that debt collectors can only sue you for debts within that time frame. Check to see how old your collections are and what the statute of limitations is in your state. Also, keep in mind that you can restart the 3-6-year clock all over again if you promise to pay, make partial payments, or even acknowledge your debt.

Don’t Reactivate your Account

The effect of old collections on your credit history reduces over time. When you start paying off debts that are old, your account gets reactivated and reported to your credit reports all over again. Do not discuss your old collections with debt collectors if you are planning to apply for a mortgage. You don’t want to reactivate your accounts. If lenders are contacting you, ask them to provide proof or documentation that you owe them and that they are authorized to collect that debt.

Set up Payment Plans

If you have a large recent debt, reducing the amount you owe can help you qualify for a larger mortgage. Consider negotiating with collection agencies to set up a repayment plan ordebt settlement. Any solution that allows you to reduce your outstanding debt can improve your chances of qualifying for a mortgage.

Mortgage Options for Borrowers with Collections

The minimumcredit score required for a conventional mortgage is 620. However, FHA loans usually have lower FICO score requirements. The best way to get a mortgage with collections when you don’t meet this minimum threshold is through a subprime lender or a B lender.

These financial institutions work with borrowers who do not have good credit scores. If you have gone through bankruptcy in the last two years, you may have to borrow from a private mortgage lender.

Work with a mortgage broker to explore your options.Getting a home loan with a 650 credit score or lower will usually be more expensive than conventional home loans. B lenders usually charge a processing fee, which is usually around 1% of the mortgage value. If you work with a mortgage broker, they’ll also charge you an additional 1%. Also, the mortgage rates you’ll qualify for will be notably higher.

Another option to consider is to have a co-signer with a good credit profile. This may help you secure better rates, but keep in mind that if you fail to pay the mortgage, the co-signer will also be responsible. A joint mortgage is also an option you may want to consider.

The Truth About Qualifying for a Mortgage with Collections

Mortgage options for those with collections are limited and more expensive when compared to borrowers with good credit. That said, there are several things you can do to improve your creditworthiness and your credit score before you apply for a mortgage.

One option is to improve your DTI ratio by paying down your debts and unpaid collections. If you have over $10k in unsecured debts, consider debt relief options like debt consolidation, debt settlement, and debt management plans. Get in touch with TurboDebt and take advantage of our free consultation to see how we can help you find the rightdebt relief option for your individual needs.