Do medical collection accounts hurt your chances of buying a house? They most certainly influence the mortgage loan application and approval process in two very profound ways.
First, unpaid doctor or hospital bills can sometimes inflate your debt to income ratio. Lenders use this fraction to determine how much home you can afford without falling behind on payments.
Second, medical debt can appear on your consumer report. When it does, it can hurt your credit score – depending on the version used. Also, lender guidelines for conventional and government secured mortgages sometimes differ in how they treat collection accounts on your file.
Explore several strategies to improve your eligibility in both areas.
How Medical Bills Affect Credit When Buying a House
Unpaid medical bills can affect your credit when buying a house, if they appear on your consumer report if the scoring equations subtract points, and if the mortgage lender guidelines pertain to your situation.
That introductory sentence includes three big ifs, which we explore in detail below. Remember, every person’s situation is unique, as are the lenders evaluating your application.
Medical collection accounts can also affect the credit score that mortgage companies use to make approval and interest rate decisions. The scoring equations use data found on your consumer report to calculate a number that predicts future delinquency.
Keep in mind that the industry uses many different scoring equations. Also, the companies who develop these algorithms update them periodically, and the lenders who use the formulas adopt the newer versions at different times.
- FICO ® 8
- Ignores collection accounts under $100
- Does not distinguish between types of collection accounts
- FICO ® 9
- Disregards all paid collection accounts
- Differentiates between medical and other accounts
- Vantage 3.0 and 4.0
- Ignore paid collections
- Do not rate medical accounts under six months old
- Used most frequently by education websites
In addition to these score and version variations, the industry uses a “Mortgage Overlay” to fine-tune the predictions. The general-purpose FICO and Vantage equations forecast delinquency on any obligation, which might include credit cards, auto loans, personal loans, and other contracts. In contrast, a mortgage overlay predicts whether you are likely to be delinquent on home loan payments only.
Unfortunately, it is difficult to determine how these overlays treat medical collection accounts.
Some unpaid medical bills appear on your consumer credit report, and some do not. Naturally, your mortgage lender will be most concerned with the negative trade lines that display after they pull a copy of your file.
- Most doctor and hospital account receivable departments do not report to the bureaus
- Medical collection agencies frequently report to the agencies to compel payment
- Consumer reporting agencies are legally bound to treat medical debt differently
- Delay display until 180 days past due
- Delete related civil judgments temporarily
If one of these negative entries appears on your consumer report, your home loan lender may ask you to write a letter of explanation. Keep the message short, and explain in simple terms the extenuating circumstances behind why the medical debt remains unpaid. For example, you could state that your insurance company is still processing the claim or that you became suddenly ill or suffered a severe accident.
Finally, each mortgage lender will follow specific guidelines regarding medical collections that might appear on your consumer credit report. The guiding principles vary slightly depending on whether you are seeking a conventional, conforming, or government-backed loan. However, the scoring equations remain the same and influence your qualifications, as noted above.
Federal agencies back government mortgages and enable borrowers with marginal qualifications to improve their odds of a home loan approval.
The Federal Housing Administration (FHA) insures loans so that mortgage companies can offer a better deal to first-time homebuyers and other consumers unable to make a sizable down payment. The most recent FHA guidance excludes medical accounts in two underwriting areas.
- Collection accounts and judgments
- Disputed derogatory items
The Veteran’s Administration (VA) helps active service members, veterans, and eligible surviving spouses become homeowners. The VA guarantees a portion of loans originated by private finance companies, enabling the lender to provide you with more favorable terms.
The VA underwriting guidelines allow the lender to ignore a bankruptcy discharged less than two years ago unless the applicant meets two conditions.
- Obtained consumer items on credit after the bankruptcy and has satisfactorily made the payments over a continued period
- Circumstances beyond the control of the applicant or spouse caused the bankruptcy, such as medical bills not covered by insurance
The United States Department of Agriculture (USDA) provides zero down payment mortgages for eligible rural and suburban homebuyers. Qualified applicants have income below 115% of the median area income, the residence is in a qualifying area, and the person meets other credit criteria.
The USDA underwriting guidelines include several statements regarding medical collections.
- May omit from credit review when mitigating circumstances were involved
- Exclude from debt ratios in capacity analysis
- Excuse bankruptcy under three years for mitigating circumstance reasons
Conventional mortgages refer to home loans that a government agency does not issue or secure. Instead, private lenders (Banks, Savings and Loans, Credit Unions) or government-sponsored enterprises (GSE) issue or secure conventional contracts.
Conventional loans can be conforming or non-conforming.
- Conforming loans comply with GSE guidelines
- Non-forming contracts often exceed the lending limits (jumbo loans)
The Federal Home Loan Mortgage Corporation (Freddie Mac) is a government-sponsored enterprise that buys loans from originators and sells them as mortgage-backed securities to other investors.
The Freddie Mac underwriting guidelines indicate, “Each Borrower must have no collections (other than medical), judgments, or tax liens filed in the most recent 24 months.”
The Federal National Mortgage Association (Fannie Mae) is another government-sponsored enterprise and is a leading source of financing for mortgage lenders, providing access to affordable home loan financing in all markets at all times.
The Fannie Mae underwriting guidelines indicate, “Lenders are not required to investigate disputed medical trade lines.”
How Medical Bills Affect Debt-to-Income Ratio
Unpaid medical bills can affect your home loan Debt to Income (DTI) ratio when you are buying a house. Originators use this fraction to determine how well you can afford future payments. The lenders divide your monthly payments for selected obligations by your gross monthly income to arrive at two sets of figures.
- Front End DTI – counts your primary housing expenses, which include principal, interest, insurance, and real estate taxes. The standard cap is 28%.
- Back End DTI – include the front-end component and then adds all other borrowing commitments including car loans, auto leases, student loans, minimum credit card payments, and other obligations expecting to last ten months or longer. The typical cap is 36%.
Mortgage companies usually include medical debt into the back-end calculation if you expect to take more than ten months to retire the obligation, and have a written payment plan contract. However, DTI often does not include every unpaid invoice.
- Amounts that you dispute due to balance billing
- Charges pending health insurance claims payments
- Obligations arising from extenuating circumstances
People with vast ($10,000 or more) sums of unpaid doctor and hospital bills are often unable to qualify for a home loan because of a high backend DTI. A debt relief program can reduce what you owe each month. Enrolling in such a program could help you reach a legal settlement to pay only a fraction of the requested amount.
Keep in mind that this approach could delay your dreams of homeownership for a long time.
- You must fund an escrow account with at least 1/3 of the amount owed to entice creditors with an immediate partial payment. It takes time to accumulate enough money.
- You fund the escrow account by diverting payment from all creditors, which also establishes financial hardship. Creditors agree to settle for part of the money owed when they fear to get nothing instead.
- Major derogatory marks appear on your consumer report and remain for seven years after the date of first delinquency. The negative marks hurt your credit score during this time.
Debt consolidation is another alternative if your unpaid medical bills are keeping you from getting a home loan. You could qualify for that dream home right away only if you can push your back-end DTI a little bit lower. Stretching out the repayment terms can lower the numerator in the fraction.
A debt consolidation loan can elongate repayments terms. If approved, use the resources to retire your outstanding medical bills. You still owe the same amount of money, but your monthly payment may be smaller. The lender will charge interest and an origination fee. Include this in your calculations.
Consolidation has one other benefit. It can immediately improve your credit report and score when the collection agency updates your account from unpaid to paid. As you will shortly see, satisfying medical collection accounts is the best strategy for qualifying for a mortgage. The other options are less appealing.