New rules help, but also restrict, debt

Homebuyers who have debts that have gone into collection are not automatically disqualified from obtaining a mortgage through the Federal Housing Administration, but new rules will soon require those homebuyers to at least set up a payment plan for delinquent credit accounts before closing on a house.

The new FHA standards going into effect on July 1 also will give prospective homebuyers a chance to dispute debts that do not belong to them because of identity theft, credit card theft or other types of financial fraud. Those debts will not be counted against them.

But any legitimate debt or combination of debts in collection totaling $1,000 or more must either be paid off or the borrower must set up a payment plan and make three timely payments to demonstrate to FHA underwriters that they can pay the debt and handle the mortgage.

FHA will continue to require all court-ordered judgments for unpaid debt to be paid in full before approving mortgage loans.

The new rules could delay many FHA real estate closings by at least three months, as homebuyers work to make three timely payments on accounts in collection. Payment arrangements also will be included in the calculation of the borrower's debt-to-income ratios, which could cause a potential buyer to be turned down for a mortgage.

"We do this to protect the financial health of FHA and to protect families who might otherwise be getting into mortgages they can't sustain," said Brian Sullivan, a spokesman for the Department of Housing and Urban Development in Washington, D.C.

While FHA has historically provided home loans to low-income borrowers with less than stellar credit and little money saved for a down payment, the federal agency is being forced to take greater precautions at a time when the nation is faced with a housing crisis brought on by millions of foreclosures.

Loan volume for FHA mortgages has exploded since the onset of the housing crash. The agency's market share for home purchases has spiked from 6 percent of all U.S. home purchases in 2007 to 30 percent as of December 2011, because more borrowers are unable to qualify for conventional loans from commercial banks.

Conventional loans usually require at least a 20-percent down payment, whereas FHA mortgages have a minimum requirement of only 3.5 percent down for borrowers with the best credit scores. FHA applicants with credit scores of less than 580 must raise at least 10 percent of a home's purchase price for a down payment. Applicants with a credit score of less than 500 do not qualify.

The new rule on collections accounts was published at the end of February and was supposed to go into effect on April 1. But an outcry from lenders, real estate agents and other real estate industry professionals who rely on FHA home sales caused HUD to postpone the start date.