Can I Get a Mortgage With Charge-Offs?

Obtaining a mortgage can be complex, and charge-offs on a credit report often concern prospective homeowners. While charge-offs indicate past financial difficulty, they do not automatically disqualify an individual from securing a home loan. Understanding how lenders view these marks is key to navigating this challenge.

Understanding Charge-Offs

A charge-off occurs when a creditor formally removes an unpaid debt from its active accounts and records it as a loss. This typically happens after a borrower has missed several consecutive payments, often between 120 and 180 days past due. Despite being written off by the creditor for accounting purposes, the borrower remains legally obligated to repay the debt.

When an account is charged off, it appears on the credit report with a “charge-off” status. This negative mark can significantly lower credit scores, as payment history is a major factor in credit scoring models. It can remain on credit reports for up to seven years from the date of the original delinquency.

A charge-off is distinct from a collection account. A charge-off signifies the original creditor’s decision to write off the debt as a loss. A collection account arises when the unpaid debt is sold or transferred to a third-party collection agency. If a charged-off debt is sold, both the original charge-off and the new collection account may appear on the credit report.

Mortgage Eligibility with Charge-Offs

Securing a mortgage with charge-offs is achievable, but eligibility depends on several factors lenders evaluate. The recency of the charge-off significantly impacts its perceived risk; older charge-offs have less negative influence. Lenders also examine the current status of the charged-off account, differentiating between accounts paid in full, settled for a lesser amount, or remaining unpaid. The specific type or source of the charge-off, such as a credit card, medical bill, or student loan, can also influence a lender’s assessment.

An applicant’s overall credit profile plays a role in mortgage eligibility. Lenders consider payment history on other open accounts, credit utilization ratios, and the length of credit history. A strong positive payment history on other debts can help mitigate the negative effect of a past charge-off. The Debt-to-Income (DTI) ratio, comparing monthly debt payments to gross monthly income, is also important, as a high DTI can signal an inability to manage additional debt.

Conventional Loans

Conventional loans, backed by Fannie Mae and Freddie Mac, generally have stricter requirements. For a single-unit primary residence, borrowers may not need to pay off outstanding non-mortgage charge-offs. For multi-unit owner-occupied properties or second homes, non-mortgage charge-off accounts exceeding $5,000 may need to be settled by closing.

For investment properties, accounts over $250 or a cumulative total exceeding $1,000 often require resolution. If a conventional loan requires manual underwriting, any accounts of $250 or more, or a cumulative total over $1,000, must be paid off, excluding medical debts. A mortgage charge-off may require a waiting period of four to seven years for a conventional loan.

FHA Loans

Federal Housing Administration (FHA) loans often offer more flexibility. FHA guidelines do not require borrowers to pay off outstanding charged-off accounts to qualify. However, lenders may impose their own requirements, known as “overlays,” which could necessitate payment. While FHA guidelines do not mandate including charge-off balances in DTI calculations, particularly for medical charge-offs, some lenders’ overlays might still consider them. For FHA loans, a mortgage charge-off has no waiting period if no lien exists on the property, but a three-year waiting period applies if a lien is present.

VA Loans

Veterans Affairs (VA) loans are known for their leniency regarding credit issues. The VA does not require charge-offs or collection accounts to be paid off for loan approval. Underwriters may request an explanation for these accounts, and a consistent repayment plan can be a positive factor. While the VA does not set a minimum credit score, most lenders look for a score around 580 or higher for VA loans. Manual underwriting is an option for lower scores, and lenders will closely examine financial activity for at least 12 months, particularly consistent on-time payments.

Portfolio Lenders

Portfolio lenders, which originate and hold loans on their own books rather than selling them on the secondary market, may offer more flexible criteria. These lenders have discretion in their underwriting standards and might be more willing to approve mortgages for applicants with charge-offs, especially if other aspects of their financial profile are strong. Their flexibility can provide an alternative for borrowers who do not meet the strict guidelines of conventional or government-backed programs.

Strategies for Mortgage Approval

Addressing charge-offs directly can improve the chances of mortgage approval. While paying off a charge-off will not remove it from the credit report, its status will update to “paid” or “paid in full,” which lenders view more favorably. Negotiating a settlement for less than the full amount is another option, though the account status will reflect “settled.” Forgiven debt from a settlement may have tax implications and could be considered taxable income.

Improving overall credit health is important. Consistently making all other bill payments on time is crucial, as payment history is a major factor in credit scoring. Reducing other outstanding debts, such as credit card balances, can lower credit utilization and improve the Debt-to-Income ratio, both of which positively impact credit scores. Avoiding new credit applications during the mortgage process can prevent further inquiries, which can temporarily lower scores. Regularly reviewing credit reports from all three major bureaus (Experian, Equifax, and TransUnion) is important to identify and dispute any inaccuracies or fraudulent entries, as these can be removed.

Preparation for the mortgage application involves gathering financial documentation, including income statements, tax returns, and bank statements. Be transparent with potential lenders about the charge-off, as they will discover it during the credit check. Prepare to explain the circumstances that led to the charge-off. A clear explanation, especially if the charge-off resulted from extenuating circumstances like job loss or medical issues, can help lenders understand the situation.