Does Medical Debt Affect a Mortgage Application?

Medical debt can be a concern for individuals navigating their financial lives when applying for a mortgage. The presence of medical debt often raises questions about its potential impact on creditworthiness and a lender’s willingness to approve a home loan. Understanding how this debt is treated by credit reporting agencies and mortgage lenders is important. Recent changes in how medical debt appears on credit reports have altered its influence, but its overall effect on a mortgage application still warrants careful consideration.

Medical Debt and Credit Reports

Medical debt does not appear on credit reports until sent to a collection agency. Providers attempt to collect payments directly for 60 to 120 days before referring unpaid amounts to collections. Once a medical bill goes to collections, it can be reported to the three major credit bureaus. This reporting historically impacted credit scores, potentially lowering them.

Changes have been implemented regarding how medical debt appears on credit reports. As of July 2022, all paid medical collection accounts were removed from credit reports. Once a medical debt in collections is paid off, it no longer negatively affects a consumer’s credit file. Additionally, the waiting period before unpaid medical collection debt appears on a credit report was extended from six months to one year, providing consumers more time to resolve bills before they are reported.

Further changes in 2023 provided relief. Beginning in April 2023, unpaid medical collection accounts under $500 were removed from credit reports. This measure reduces the number of medical debts appearing on consumer credit files, as many are for smaller amounts. These adjustments aim to lessen the burden of unexpected medical expenses on consumers’ credit profiles.

Credit scoring models treat medical collections differently. Newer FICO Scores, like FICO Score 9, disregard paid collection accounts and differentiate between unpaid medical and non-medical collections, giving less weight to medical debt. This can result in a higher score for individuals whose only derogatory mark is medical debt. VantageScore models (3.0 and 4.0) have also evolved to exclude all medical collection data from credit score calculations, regardless of the amount owed or the age of the collection. These updated scoring methodologies reflect a growing understanding that medical debt often arises from unforeseen circumstances and may not accurately predict a borrower’s overall creditworthiness.

How Lenders Assess Medical Debt

Mortgage lenders evaluate a borrower’s financial health beyond just a credit score. While recent changes in credit reporting have reduced the direct impact of medical debt on scores, lenders still assess the overall financial picture, including any outstanding collections. The presence of collections, even medical, can be viewed as an indicator of financial risk. Lenders consider how these debts might factor into a borrower’s ability to manage new mortgage payments.

Lenders use the debt-to-income (DTI) ratio, which compares total monthly debt payments to gross monthly income. While medical collections may not always have a scheduled monthly payment, their presence can influence DTI. For instance, if a significant unpaid medical collection exists, some lenders or loan programs might require a payment arrangement to be established, and this payment would then be factored into the DTI calculation. A higher DTI ratio can indicate difficulty managing additional debt and may reduce loan approval or lead to less favorable terms.

Guidelines for medical collections vary across mortgage loan types. For Conventional loans, backed by Fannie Mae and Freddie Mac, medical collections are treated more leniently. They often do not require these debts to be paid off, and their presence may not prevent loan approval, especially for single-unit primary residences. Fannie Mae’s automated underwriting systems may disregard medical collections.

FHA loans have distinct requirements. FHA guidelines do not require medical collections to be paid off for loan qualification, acknowledging they often arise from unexpected situations. However, if non-medical collection accounts exceed $2,000, FHA guidelines may require lenders to include a hypothetical payment of 5% of the outstanding balance in the borrower’s DTI calculation. While medical collections are usually exempt from this 5% rule, individual lenders might still consider the overall impact or impose their own stricter “overlays” beyond the minimum FHA guidelines.

VA loans are flexible regarding medical debt. The VA treats medical collections leniently and does not require them to be paid off for loan approval. Unless there is an active payment plan for a medical collection, it is not factored into the DTI ratio for VA loans. The VA has implemented rules to limit when medical debts are reported to credit bureaus, focusing on cases where other collection efforts are exhausted and the debt exceeds $25.

Overall Impact on Mortgage Applications

Medical debt can influence a mortgage application, even with recent credit reporting changes. While smaller or paid medical collections no longer appear on credit reports or have a reduced impact on credit scores, larger unpaid medical debts can pose challenges. Significant unpaid collections can raise red flags for lenders, signaling financial instability. This can affect mortgage eligibility, potentially leading to a loan denial if the debt is substantial and unaddressed.

Even if a mortgage is approved, medical debt can impact loan terms. Lenders assess risk, and significant unpaid collections might lead to a higher interest rate or less favorable loan terms. A higher interest rate can increase the total cost of the mortgage. The applicant’s overall financial profile, including other debts, income stability, and payment history, plays a role in determining the impact.

The effect of medical debt on a mortgage application is variable, depending on the amount, status (paid or unpaid), and how recently it went into collections. While credit bureaus and government-backed loan programs are more lenient with medical debt, lenders retain discretion. They may have internal policies, known as “overlays,” that are stricter than the minimum agency requirements. These overlays can sometimes require significant medical collections to be addressed or paid off before a loan is approved, even if not explicitly mandated by the loan program’s core guidelines.

While medical debt is treated differently than other consumer debt by credit bureaus and some lending programs, its presence can factor into a lender’s risk assessment. The goal for a mortgage applicant is to present the strongest financial standing. Understanding how medical debt is reported and assessed allows applicants to proactively address issues, such as verifying credit report accuracy or establishing payment arrangements for larger outstanding medical collections, improving their chances of a successful mortgage application.