Can You Get a Mortgage With Charge Offs?

Homeownership can be challenging, especially with past financial difficulties on a credit report. Charge-offs are a common concern for aspiring homeowners. These credit blemishes can impact mortgage eligibility. This article explores charge-offs, their role in lender assessments, and strategies to improve mortgage readiness.

What a Charge-Off Is

A charge-off occurs when a creditor formally deems an unpaid debt as a loss, typically after 120 to 180 days of non-payment. Though written off for accounting, the borrower remains legally responsible.

Once charged off, an account appears on a credit report as a derogatory mark, showing its status and the written-off balance. This negative entry severely impacts credit scores. It typically remains on a credit report for up to seven years from the first missed payment.

A charge-off differs from a collection account, though often related. A charge-off is the original creditor’s declaration that debt is uncollectible. A collection account arises when the charged-off debt is sold to a third-party agency. Thus, a single debt can result in two negative credit report entries.

How Lenders Assess Credit

Mortgage lenders evaluate a borrower’s financial health using credit scores, payment history, and debt-to-income (DTI) ratio. They also consider financial reserves, like savings, to ensure a borrower can handle unexpected expenses.

A charge-off significantly impacts these factors. It substantially lowers credit scores, signaling payment default and increased risk. Lenders view charge-offs as financial difficulty, raising concerns about future mortgage payments. An unpaid charge-off suggests an inability to manage debt effectively.

Lenders often apply “seasoning” periods, requiring time to pass since the charge-off before considering an application. This waiting period, from months to years, allows lenders to observe renewed financial stability. While a charge-off remains on a credit report for seven years, its impact on credit scores may lessen after about two years. Lenders examine the entire credit profile, including positive payment histories and overall debt management.

Improving Your Mortgage Readiness

Addressing a charge-off improves mortgage readiness. One approach is paying the charged-off amount in full. This changes the status to “paid charge-off” on your credit report, viewed more favorably by lenders than an unpaid status. Paying in full can also improve credit scores over time, demonstrating responsibility.

Another option is to settle the debt for less than the full balance. This involves negotiating with the original creditor or collection agency. If successful, the credit report will show the account as “settled for less than full balance.” While less positive than paying in full, it is better than leaving the debt unpaid and helps resolve the obligation.

If a charge-off entry appears inaccurate, disputing it is an option. Consumers can challenge wrong, incomplete, or unverifiable information by contacting credit bureaus (Experian, Equifax, and TransUnion) or the original creditor. If successful, the entry may be corrected or removed, improving the credit profile.

Beyond addressing the charge-off, broader strategies enhance credit health. Consistently making other payments on time is important, as payment history is a significant factor. Reducing credit utilization also positively impacts scores. Avoiding new debt and building positive payment history demonstrates financial responsibility. Maintaining stable employment and financial reserves strengthens your profile, improving DTI and appeal to lenders.

Mortgage Options with Charge-Offs

Securing a mortgage with charge-offs is possible, though requirements vary across loan types. Each program has guidelines for derogatory credit marks, offering different flexibility levels.

Federal Housing Administration (FHA) Loans

FHA loans are often more forgiving for borrowers with past credit issues, including charge-offs. FHA guidelines generally do not require charge-offs to be paid off for qualification, but lenders consider them. While FHA has no strict waiting period for non-mortgage charge-offs, some lenders may require re-established credit for 12 to 24 months. Medical collections and charge-offs are typically treated leniently and excluded from DTI calculations.

Veterans Affairs (VA) Loans

VA loans are often the most lenient regarding charge-offs and collections for eligible service members and veterans. The VA does not mandate charge-offs be paid off, focusing on payment history and requiring a letter of explanation. While VA has no minimum credit score, many lenders look for 580 or higher. Lenders assess financial stability over the past 12 months; strong compensating factors like stable employment or low debt can help.

Conventional Loans

Conventional loans, backed by Fannie Mae and Freddie Mac, generally have stricter credit requirements. While flexible, they often require longer seasoning periods (two to four years) or full payment of charge-offs. For a single-unit primary residence, non-mortgage charge-offs or collections may not need to be paid off. However, stricter rules apply for multi-unit owner-occupied properties, second homes, or investment properties, often requiring resolution of accounts exceeding certain thresholds.

Non-Qualified Mortgage (Non-QM) Loans

Non-QM loans are an alternative for borrowers not meeting conventional or government-backed criteria. Designed for unique financial situations, they offer flexible credit requirements, potentially accommodating recent charge-offs or lower scores. However, this flexibility often comes with higher interest rates, increased fees, or larger down payment requirements.