FHA Rules for Collections & Judgments: The Uncensored Truth

One of the biggest misconceptions in real estate is that you must have a perfectly clean credit report with zero collections to buy a house. FHA does not require collection accounts to be paid off as a condition of mortgage approval. However, they do calculate the outstanding debt against your income.

Medical vs. Non-Medical Collections

The HUD 4000.1 handbook explicitly separates collections into two categories:

• Medical Collections: These are entirely excluded. They do not count toward your cumulative balance limit, and we do not calculate any monthly payment against your Debt-to-Income (DTI) ratio.
• Non-Medical Collections: These include unpaid credit cards, cell phone bills, auto repossession deficiencies, etc. These are subject to the cumulative balance rule.

The $2,000 Cumulative Rule

If your total outstanding balances for all non-medical collections are equal to or greater than $2,000, the FHA requires the lender to account for this debt. We must apply one of the following methods:

• The 5% Calculation: We calculate 5% of the total outstanding balance and hit your Debt-to-Income ratio with that amount as a "monthly payment." (Example: If you have $3,000 in collections, we add $150/month to your debt profile).
• Payment Arrangement: If you have formally entered into a payment arrangement with the creditor, we use the actual documented monthly payment amount.
• Pay at Closing: If the 5% calculation pushes your DTI too high, you have the option to pay off the collections at (or before) closing.

Judgments and Federal Tax Liens are significantly more serious than standard collections because they can attach to the title of the new property you are buying. By default, FHA requires all judgments and liens to be resolved or paid in full prior to closing. However, there is a massive exception.

The Payment Plan Exception

If you cannot afford to pay off a large judgment or tax lien in full, you can still secure an FHA loan by establishing a formal, written payment agreement with the creditor or the IRS. To be eligible to close, you must meet the following criteria:

• You must provide a copy of the fully executed payment agreement.
• You must prove that you have made at least three consecutive, scheduled monthly payments on time.
• The agreed-upon monthly payment will be included in your DTI calculation.

Warning: You cannot cheat the system by prepaying the three months all at once. FHA explicitly states: "The Borrower may not prepay scheduled payments in order to meet the required minimum of three months of payments." They must be verified as three distinct, monthly payments.