Understanding How Conventional And FHA Loans Handle Derogatory Accounts

When securing a mortgage, derogatory accounts such as collections, charge-offs, judgments, and unpaid taxes can significantly impact your ability to qualify for a loan. However, how these accounts are handled varies greatly depending on whether you’re applying for a Conventional loan (backed by Fannie Mae) or an FHA loan.

Below, we break down how Conventional and FHA loans approach derogatory accounts, including what must be paid off before closing and what may remain open.

Collection Accounts

FHA Loans:

Collection accounts must either be paid in full prior to closing OR you can use 5% of the outstanding balance and include it in your debt-to-income (DTI) ratio.
No additional documentation is required.

Conventional Loans (Fannie Mae):

Primary Single-Family Homes: An unlimited amount of collection accounts may remain unpaid.
Primary 2–4-Unit Properties: If the total collection accounts exceed $5,000, they must be paid off before closing.
Investment Properties: Either 250percollectionaccountor250percollectionaccountor1,000 cumulative must be paid off prior to closing.

IRS Taxes Due

FHA Loans:

You must have a 3-month payment history, but the payments do not need to be made prior to closing.

Conventional Loans (Fannie Mae):

At least one payment must be made before closing.
Proper documentation of the IRS payment plan is required.

Non-Mortgage Charge-Offs

FHA Loans:

Non-mortgage charge-offs may remain unpaid.

Conventional Loans (Fannie Mae):

Primary Single-Family Homes: An unlimited amount of charge-offs may remain open.
Primary 2–4-Unit Properties or Investment Properties: Refer to the collection account guidelines above for amounts that must be paid off.

Judgments

FHA Loans:

You must have a 3-month payment history, but the payments do not need to be made prior to closing.
Proper documentation regarding the terms of the payment plan is required.

Conventional Loans (Fannie Mae):

Judgments must be paid in full prior to closing.

Key Takeaways

FHA Loans tend to be more flexible with derogatory accounts, allowing some to remain unpaid or incorporating them into your DTI.
Conventional Loans have stricter requirements, especially for investment properties and multi-unit primary residences.