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.
Medical Bills Affect Credit
Unpaid medical bills can affect your credit when buying a house if they appear on your consumer report if the scoring equations subtract points if you have not paid them off, and if you are applying for a mortgage after July 1, 2022.
That introductory sentence includes four significant if statements, which we explore below. Remember, every person’s situation is unique.
Credit Report
Medical debt can affect your credit report when buying a house if the negative entries appear on your file. Several new rules[1] change how these data are displayed at Experian, Equifax, and TransUnion, and the timing could be critical.
- Effective July 1, 2022, unpaid medical collections begin displaying after twelve months instead of only six, and paid debt will immediately disappear rather than aging from the file after seven years.
- Effective 2023, the bureaus will no longer display medical collection accounts under $500.
The most important credit bureau when buying a house could be the one with the most damaging information, which might include medical collections. Lenders typically utilize a tri-agency merged report.
Paying Off
Shoppers should pay off medical collections before buying a house, especially if they plan to close after July 1, 2022. The new rules cited above will instantly drop the negative entry from your credit report.
Therefore, homebuyers should review their file at each of the three agencies and identify any outstanding balances they can repay to improve their qualifications immediately.
An income-based personal loan might provide the funding to pay off the medical collection account. The impact on your mortgage interest rate could make this move an excellent investment. For instance, shaving 1% from a $300,000 30-year home loan saves $47,371!
Settling Debt
Consumers should avoid settling medical debt before buying a house because the opposite happens: the negative mark will remain on your credit report until it ages off your file seven years after the date of first delinquency.
The process of settling medical collections poisons your ability to qualify for a mortgage because you must demonstrate financial hardship to entice the agency to accept immediate partial payment to satisfy the obligation.
You must become delinquent on all obligations for settlement to work. You could save a bundle on your unsecured debt while ruining your credit and chances of buying your dream home.
Credit Scores
Medical bills appearing on your consumer report can negatively affect your credit score, the magic number lenders use to predict your probability of future default.
The toughest scoring credit bureau for you could be the one with unpaid medical bills appearing on its file. Some medical collection agencies do not automatically report to Experian, Equifax, and TransUnion. Sometimes, they transact with just one or two.
Finally, the industry uses many scoring equations that address the issue differently.[2] Also, the companies who develop these algorithms update them periodically, and the lenders who use the formulas adopt the newer versions on their timetables.
- FICO® 8
- Ignores collection accounts under $100
- It does not distinguish between types of collection accounts
- FICO® 9
- Disregard all paid collection accounts
- Differentiates between medical and other accounts
- Vantage® 3.0 and 4.0
- Ignore paid collections
- Do not rate medical entries under six months old
- Used most frequently by education websites
Medical Collections Affect Mortgage
Medical collections can negatively affect getting a mortgage and the interest rate you pay if you are approved, making buying a house more challenging—but not impossible.
Expect the issue to affect the Debt-to-Income ratio, industry-specific mortgage overlay scores, and underwriting guidelines published by government agencies.
Debt-to-Income
Medical collections might impact your ability to get a mortgage approval by pushing your Debt-to-Income (DTI) ratio higher. Home lenders use the DTI to measure whether you can afford the projected monthly payment, considering two metrics.
- Front–end DTI counts your primary housing expenses, including principal, interest, insurance, and real estate taxes. The standard cap is 28%.
- Back-end DTI: Include the front–end component and add all other borrowing commitments, including car loans, auto leases, student loans, minimum credit card payments, and other obligations expected to last ten months or longer. The typical cap is 36%.
Unpaid medical bills do not directly affect the back-end DTI unless you have a written payment plan for more than ten monthly installments. However, the negative mark on your credit report could translate into higher mortgage interest rates, which hurts the front-end DTI.
High DTI personal loans can help you retire your medical debt. Remove it from your credit report while lowering the remaining monthly payments on other obligations such as credit cards.
Mortgage Overlay
Medical collections hurt your chances of getting a mortgage less than other derogatory marks because lenders utilize a credit score optimized for home loans.
- The better-known FICO® and Vantage® credit scores predict future delinquency for all types of transactions, including unsecured accounts.
- A mortgage overlay score estimates your potential to default on one specific trade line: a secured home loan.
People encountering financial hardship tend to default on their unsecured obligations first because the lender has no collateral to repossess. Meanwhile, the consequences for missing consecutive mortgage payments are more severe: foreclosure.
Agency Guidelines
Specific guidelines issued by different agencies determine how medical collections appearing on your credit report will affect a mortgage approval and interest rate.
Conventional Mortgages
Rules issued by two government-sponsored enterprises dictate how medical collections displayed on credit reports affect conventional mortgages. A conventional home loan meets the requirements of Fannie Mae or Freddie Mac.
- Down payment percentage
- Private mortgage insurance
- Credit score minimum
- Debt-to-Income ratio (DTI)
- Loans size
The Federal Home Loan Mortgage Corporation (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) underwriting guidelines indicate, “Lenders are not required to investigate disputed medical trade lines.”
Government-Backed
The rules formulated by several government agencies that back home loans for people with low incomes or poor credit scores can affect how medical collections affect mortgage approvals and interest rates.
These government agencies insure mortgages from default, making it easier for marginal borrowers to qualify but with higher monthly payments.
The Federal Housing Administration (FHA) excludes medical accounts in two underwriting areas.
- Collection accounts and judgments
- Disputed derogatory items
The Veteran’s Administration (VA) allows the lender to ignore a bankruptcy discharged less than two years ago if 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 applicant’s or spouse’s control caused the bankruptcy, such as medical bills not covered by insurance.
The United States Department of Agriculture (USDA) underwriting guidelines include several statements regarding medical collections.
- Omitted from credit review when mitigating circumstances were involved
- Exclude from debt ratios in capacity analysis
- Excuse bankruptcy under three years for mitigating circumstance reasons
Article Citations:
[1] Equifax Medical Collections Credit Reports
[2] Experian Medical Bills Credit Reports
