FHA ML 2012-3 requiring collections to be paid off is a credit score trap!

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FHA is always tweaking the system, one of the latest can be a real booby trap for borrower's credit score. Recent changes has a direct effect on how some FHA loan applicants are approved--or denied. This new change for FHA underwriting approval will likely result in even more denials.
On March 1, 2012, HUD published mortgagee letter 2012-3, containing some significant underwriting changes regarding unpaid collection accounts. The important revisions to the instructions for FHA lenders are found in HUD 4155.1 .4C.2.E.
The new guidelines state "If the borrower has individual or multiple collections with an aggregate dollar amount equal to or in excess of $1000, the accounts must be resolved or payment arrangements made with 3 months of payments made on time, prior to or at the time of closing." Since the type of collections is not specified in the current guidelines, medical collections cannot be omitted from the $1000 threshold, so they are included in the total.
Borrowers should be aware that the rule does not require a collection to be paid in full, but that an agreement has been made with the creditors and payments rendered as agreed for three months or more. A judgment ordered by a court would be required to be paid in full however, that has always been the case.
The snare is that the borrower may not be aware that paying off old collections will actually lower their credit score. So by trying to adhere to criteria, they are shooting themselves in the foot regarding their credit score.
It is better to have old collections than new paid collections. Any new activity on an old account, even if it is being paid off, will refresh derogatory items, updating the date of last activity, resulting in a hit to their credit score.
Buyer beware! Borrowers credit score is at risk when arranging a payment agreement or paying off old collections.
Your best bet may actually to remove an much of the collections as possible rather than update them. This may help the borrower get under the $1000 threshold. Consider disputing the collections or consider the solution of credit repair. This is a catch 22 situation. Best outcome is to get the borrower into credit repair and work to get the collection(s) removed altogether. If there are open disputes, they can be removed as well. Questions? Clean Slate Credit Services, www.640orFREE.com/home, 1 866 726 3535 info@640orFREE.com
Submit the loan for underwriting after the bigger collections have been disputed and removed, any remaining total less than $1000. Now you have a buyer. If you will follow this strategy while other's loans are being shot down, you will see a significant portion of market share as you are able to get loans done that others can't.
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