How to Buy a House With a Charge-Off on My Credit Report
Mortgage underwriters look at the "four C's of credit" to determine consumers' eligibility for mortgage loans, notes the Federal Housing Authority. The four C's are credit history, capacity to pay, cash assets available to close the mortgage and collateral. Credit history is the element consumers most often struggle with as they seek the mortgage pre-approval they'll need to begin searching for homes. It is possible to get a mortgage despite imperfect credit, even when the derogatory items include a charge-off.
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Charge-off Explained
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Creditors charge off debts that are 120 to 150 days past due in order to comply with federal laws mandating that creditors not count bad debts among their assets. Classifying the debt as a charge-off removes it from the creditor's balance sheet, credit expert Steve Bucci writes on Bankrate.com. The consumer still owes the debt and is still responsible for paying it, however. His credit report will reflect both the charge-off and the balance due.
Lessening a Charge-off's Impact
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Paying the balance due should improve your credit score and reduce the negative impact the charge-off has on your ability to qualify for a mortgage loan, even though the charge-off stays on your credit report for seven years. Repayment is helpful in two ways. First, according to Bills.com, it removes the outstanding balance from your credit report. In addition, it reduces your debt-to-income ratio, which is the percentage of your income that goes to repaying outstanding debt. A lower ratio is better because it means more of your income is available to repay a mortgage. In addition to improving your credit score, reducing the ratio boosts the second "C": capacity to pay.
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Mortgages for Damaged Credit
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Although high-rate subprime options still exist for consumers with challenged credit, an FHA-guaranteed loan is a safer alternative. The credit requirements are more liberal for FHA loans than for conventional loans because the FHA reduces the underwriter's risk by guaranteeing repayment if the borrower defaults. Another benefit is the low down payment requirement, which is 3.5 percent for borrowers with credit scores above 580 and 10 percent for borrowers with lower scores. In exchange for these perks, borrowers pay a modest mortgage insurance premium until they own 78 percent equity in their homes. Approved lenders make FHA loans available at competitive rates.
FHA Credit Requirements
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FHA will guarantee loans for consumers with charge-offs and other derogatory credit, but the negative items must be at least a year old or there must have been mitigating factors leading to a delinquency of 60 days or longer. In some cases, you must pay off collection accounts in order for the FHA to guarantee the loan. A letter of explanation detailing unusual circumstances that led to your delinquency and the actions you've taken to overcome them may increase your chance of loan approval.
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