Collection accounts, tax liens and qualifying for a mortgage
The economic climate of the past 10 years has left many borrowers facing collection accounts and civil or IRS tax liens, which can affect approval for mortgage financing. Mark Wells at Preferred Financial Services answers questions about handling these issues.
Isn’t it best to pay off all liens and collection accounts before applying for a mortgage? You would think so, but that is not always the case. Liens and judgments result in a public-record filing which automatically attaches them to any real estate you own. Since lenders will not close a mortgage loan with an outstanding lien, liens must be settled prior to closing—but how you settle them is important. Collection accounts are sometimes best left alone.
How do I settle a lien? If the lien is a state or federal tax obligation, it remains permanently on public record and must be settled. Your options are to either settle it in full—including all penalties and interest—or enter into a repayment agreement with the government, make the first three payments under the agreement, and then apply for a mortgage.
What about a civil judgement? These have a 10-year lifespan and are extinguished after that period. You can either wait until the judgment expires, or settle in full for less than what is owed as the judgment ages. Since the creditor knows his lien will expire after 10 years, the closer you are to expiration, the less the creditor is willing to take to settle in full. I strongly suggest you employ an attorney to negotiate on your behalf to assure that the lien is released legally, freeing you to close your mortgage.
Why would I leave a collection account unpaid? Different lending programs require different actions. For instance, if the total of your non-medical collections is less than $2,000, FHA will not require you to pay them off. If they are more than $2,000, FHA will allow your mortgage broker to assign a monthly payment of 5 percent of the balance to the collections. You don’t actually have to make the payment; as long you have sufficient income to make the payment and still meet debt-to-income requirements, FHA will approve the loan without paying them off.
Are there other reasons not to pay off a collection account? Yes, conventional and VA lenders rarely require them to be paid off as long as you have good credit and reasonable savings. In an odd twist, paying off an old collection account can actually lower your credit scores. Since the collection account disappears from your credit record after 7 years, if you pay off an “old/unpaid” collection, the credit system updates your records and now shows a “new/paid” collection, causing your scores to drop.
Judgments, tax liens, and collections can be complicated.
I welcome questions and comments, and can be reached at (864) 235-9596, or by email at Mark@TheGreatestRates.com.
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