The VA Has Changed How Non-Medical Collections Are Calculated

The VA issued Change 47 to VA Pamphlet 26-7, the VA Lender's Handbook.

The change affects Chapter 4, Topic 7, which deals with credit history.

The VA added the words “divided by 12 months” to the calculation for non-medical collections without an established payment arrangement.

So, the current calculation is:

It is important to understand exactly what this applies to.

This calculation is for:

Non-medical collection accounts with no established payment arrangement.

It doesn't mean every collection on a VA loan will automatically be calculated this way.

Here are a few examples:

The larger the collection balance, the more dramatic the difference becomes.

If someone has $20,000 in qualifying non-medical collections, counting $1,000 per month against them versus $83.33 per month can completely change the loan.

Mortgage underwriting isn't just looking at how much debt you owe. Underwriters also have to determine how much monthly debt to count against your income.

That's where collections can create a big problem.

A collection account may not actually require you to make a $500 monthly payment. But the underwriting guidelines may require an underwriter to count a calculated payment against you anyway.

That affects your debt-to-income ratio, commonly called DTI.

VA loans also use something called residual income.

Residual income is the VA's way of looking at how much money your household should have left over every month after the major expenses are paid.

As a result, an artificially large collection payment could hurt a borrower in more than one way.

Changing a calculated collection payment from $500 to $41.67 can make a meaningful difference.

No.

Medical collections are treated differently under VA guidelines.

Identifiable medical collections and medical charge-offs that have not been reduced to a judgment or lien can generally be disregarded.

That means we normally aren't taking the medical collection balance and applying the 5% divided by 12 calculation to it.

This change specifically deals with non-medical collections.

That's different.

The 5% divided by 12 calculation applies ONLY when there is NO established payment arrangement.

If the collection account has an established minimum payment that is being reported, the lender may use the applicable documented payment instead.

That's why I don't like giving people blanket advice such as:

Maybe.

We need to look at what is actually reporting and how the account is set up.

Not necessarily.

Having collection accounts does not automatically mean they all need to be paid before you can qualify for a VA loan.

The underwriter will still have to evaluate your overall credit history.

The VA wants to see that the applicant is an acceptable credit risk. A pattern of unpaid obligations can obviously matter, but that is different from saying:

That's not the same thing.

There can also be lender-specific requirements that are stricter than the basic VA guidelines. These are called lender overlays, which I'll explain below.

The U.S. Department of Veterans Affairs establishes the basic guidelines for VA loans.

Individual mortgage lenders can add their own requirements on top of those guidelines.

Those additional lender requirements are called overlays.

As a result, it's possible to hear:

That does not necessarily mean:

As a mortgage broker, Edge Home Finance works with a large network of wholesale lenders. If one lender has an overlay that creates a problem, we can try to find another lender that does not add the same overlay.

In fact, there are lenders that do not add certain overlays on top of the VA guidelines.

This may allow us to get a qualification with another lender for the same borrower, even though they could not get approved through the lender that had the overlay.

It doesn't mean every loan can be approved.

It just means we can't assume that one lender's answer is the final answer.

This guideline changed very recently, so it would not be a huge surprise if some lender guides, underwriting systems, loan officers, or internal procedures take a little time to catch up.

If you have a non-medical collection without a payment arrangement and your lender is still using straight 5% of the balance as your monthly payment, ask them to review the current version of:

Don't get into an argument with your loan officer. Just ask them to check it.

This is especially important if you were told you could not get pre-approved because your debt-to-income ratio was too high and you have a collection account.

For example, suppose you were trying to qualify for a VA loan with a $15,000 non-medical collection balance and no payment arrangement.

If that $750 collection payment contributed to a previous denial because your debt-to-income ratio was too high, you should try to get pre-approved again using the new calculation guideline.

It doesn't guarantee that you'll qualify now, but that's enough of a difference that it would absolutely make sense to rerun the numbers.

Getting a second opinion using the new calculation is definitely worth pursuing if you suspect this could have happened to you.

Please don't automatically start paying off collections because someone said it will help you get a mortgage.

We see borrowers pay down credit accounts and collections all the time without consulting with us first. They do this with good intentions, but their proactive actions don't always produce the positive result they expected with their credit.

Sometimes, they can even have the opposite effect.

Before paying, settling, or establishing payment arrangements on collection accounts, let your mortgage professional look at the complete credit report.

There may be a good reason to pay off the collection, but there could also be a good reason not to, or at least not immediately.

The solution might be to establish a payment arrangement instead.

In some scenarios, the collection could have very little impact on the loan under the new calculation, and the funds used to pay it off could have been used in a more impactful way.

The answer is going to depend on the actual file.

The best solution is to run the numbers first.

Not automatically.

Collections and charge-offs are not interchangeable terms in the VA guidelines.

The new 5% divided by 12 calculation specifically addresses non-medical collection accounts without established payment arrangements.

If you have charge-offs, judgments, liens, or other derogatory credit, those need to be reviewed separately.

Judgments and liens are different from ordinary collection accounts.

Don't assume that because an account originally started as a collection, the 5% divided by 12 rule will still apply after it has become a judgment or lien.

Those situations have their own requirements and should be reviewed individually.

The VA itself does not establish one universal minimum credit score for every VA loan.

However, lenders can establish their own minimum credit score overlays.

That means one lender may decline a VA borrower based on credit score while another lender may have a program that allows the same score.

The credit score is just one factor that the underwriter uses to make a decision on the file.

They still need to consider payment history, collections, housing history, debt-to-income ratio, residual income, and the overall strength of the loan.

Yes, it is possible to qualify for a VA loan with collection accounts.

Whether you qualify depends on the complete loan.

The underwriter will want to know:

• What kind of collections are they?
• Are they medical or non-medical?
• How old are they?
• Are there payment arrangements?
• Are monthly payments being reported to the credit bureaus?
• Have any become judgments or liens?
• What does the rest of your credit history look like?
• What is your income?
• What other monthly debts do you have?
• What is the amount of residual income available?
• What lender guidelines apply to the loan?

We need the whole picture.

It is difficult to review one collection account and try to give someone a yes or no answer.

Mortgages rarely work that way.

Edge Mortgage Pro is a mortgage brokerage working with a large network of wholesale lenders.

That gives us the ability to compare loan programs and lender guidelines rather than trying to fit every borrower into one lender's box.

If you are a Veteran or eligible surviving spouse and have questions about qualifying for a VA loan, we're happy to review your scenario.

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This page is for educational purposes and is based on VA guidelines available as of the date shown above. Individual lenders may have additional underwriting requirements. Loan approval depends on the complete borrower and property profile.

Edge Home Finance, LLC is a private mortgage broker and is not affiliated with or endorsed by the U.S. Department of Veterans Affairs or any other government agency.

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