For years, homebuyers believed that a single medical collection could derail their dream of owning a home. The fear was justified; traditional credit scoring models treated a past-due hospital bill the same as a willfully ignored credit card payment. However, the landscape has completely changed. Federal housing agencies and mortgage investors now recognize that medical debt is often involuntary and not a true indicator of a person's willingness to pay their mortgage. This guide breaks down the modern rules, providing the clarity you need to approach your mortgage application with confidence, even with medical debt on your credit report.
How do FHA and Conventional guidelines view medical collections?
The most significant change in mortgage lending is the distinction now made between medical and non-medical debt. Both FHA and Conventional loans have specific, and favorable, rules for handling medical collections.
FHA Loan Guidelines
For government-backed FHA loans, the rules are incredibly lenient. The FHA Handbook (HUD 4000.1) explicitly states that medical collections are disregarded when calculating a borrower's debt-to-income (DTI) ratio.
- No DTI Impact: Whether you have a $500 medical collection or a $15,000 one, the associated debt is not counted against you in the DTI calculation. An underwriter will not add a monthly payment for this debt to your liabilities.
- No Payoff Required: FHA does not require you to pay off medical collections to qualify for the loan. The accounts can remain open and outstanding through closing.
- Underwriter Discretion: While the debt is excluded from DTI, an underwriter still sees it on your credit report. A pattern of very large, very recent medical collections might prompt a request for a letter of explanation, but it will not be the basis for a denial on its own. (The data, information, or policy mentioned here may vary over time.)
Conventional Loan Guidelines
Conventional loans, which are backed by Fannie Mae and Freddie Mac, also have rules that are highly favorable to borrowers with medical debt.
- Exclusion of Paid Collections: Any medical collection account that you have paid off is completely ignored and will not impact your application.
- No Payoff Required: Similar to FHA, you are not required to pay off outstanding medical collections before closing on a conventional loan.
- DTI Calculation Rules: If a medical collection is unpaid, the lender must determine if it needs to be included in your DTI. If the credit report shows a monthly payment amount for the collection, the lender will use that figure. If no payment is listed, the lender is not required to calculate a payment, and the debt is excluded from the DTI ratio. This is a significant departure from how non-medical collections are treated, where a payment must always be calculated. (The data, information, or policy mentioned here may vary over time.)
Can a lender legally ignore medical collection accounts on my credit report?
Yes, and it's important to understand what 'ignore' means in this context. A lender cannot pretend the debt doesn't exist on your credit report. They see it. However, they are legally permitted and, in fact, instructed by FHA, Fannie Mae, and Freddie Mac guidelines to exclude it from the debt-to-income (DTI) calculation.
This is not a lender doing you a favor or bending the rules. It is the direct application of official mortgage underwriting policy. The agencies that back these loans created these specific carve-outs for medical debt because they recognize a few key truths:
- Medical Debt is Unplanned: Unlike taking on a car loan or credit card debt, medical debt is almost always the result of an unexpected emergency or illness.
- It's Not Predictive: A person's history with medical billing disputes or inability to pay a sudden $20,000 hospital bill is not a reliable predictor of their likelihood to pay a planned, monthly mortgage payment.
- Billing is Complex: Medical billing is notoriously confusing. Debts can go to collections while insurance claims are still being processed, often without the consumer's knowledge.
So, when a loan officer says they can 'ignore' a medical collection, they mean its financial impact on your qualifying ratios will be zero. The account itself is still visible to the underwriter, but it is not a barrier to approval.
Will paying off an old medical collection actually hurt my credit score?
This is a common concern rooted in how older credit scoring models worked. In the past, any activity on an old collection account, including paying it, could 're-age' the account, making it appear more recent and causing a temporary drop in your credit score.
Today, this is far less of a concern. Newer scoring models like FICO 9, FICO 10, and VantageScore 3.0 & 4.0 treat medical debt very differently:
- They give less weight to unpaid medical collections than other types of debt.
- They completely ignore collection accounts that have been paid off.
While most mortgage lenders still use slightly older FICO models (like FICO 2, 4, and 5), the negative impact of paying a collection is often minimal and temporary. The more significant risk is spending cash reserves that you might need for your down payment or closing costs. (The data, information, or policy mentioned here may vary over time.)
The Golden Rule: Never pay off a collection account during the mortgage process without first consulting your loan officer. They can run your scenario through the underwriting system and determine the precise impact, if any. Often, the best course of action is to do nothing and leave the account as is.
How is the monthly payment for medical debt calculated for my DTI ratio?
This calculation depends entirely on the loan type and what is reported on your credit file.
DTI Calculation for FHA Loans
- The calculation is simple: $0. As stated earlier, FHA guidelines exclude all medical collection debt from the DTI ratio. No monthly payment is factored into your liabilities.
DTI Calculation for Conventional Loans
- If a Payment is Reported: If your credit report shows a monthly payment for the medical collection (e.g., you are on a payment plan), the lender will use that exact amount.
- If No Payment is Reported: This is the most common scenario. Unlike non-medical collections where a lender must calculate a payment (such as 5% of the balance), for medical collections, no payment needs to be calculated. The debt is effectively excluded from the DTI. (The data, information, or policy mentioned here may vary over time.)
Example Scenario: A borrower has a $4,000 medical collection on their credit report with no payment amount listed.
- FHA Application: The $4,000 balance is ignored for DTI purposes.
- Conventional Application: The $4,000 balance is also ignored for DTI purposes because no monthly payment is listed.
Now, compare this to a $4,000 credit card collection. For a conventional loan, the lender would have to calculate a monthly payment, potentially $200 (at 5%), which would be added to the borrower's DTI and could reduce their purchasing power. (The data, information, or policy mentioned here may vary over time.)
What's the difference between a medical charge-off and a collection?
While they sound similar and both negatively affect credit, they represent two different stages of unpaid debt.
- Charge-Off: This is an accounting action taken by the original creditor (e.g., the hospital or clinic). After a period of non-payment (usually 120-180 days), the creditor gives up on collecting the debt themselves. They 'charge it off' their books as a loss. The debt is still legally owed, and the charge-off remains on your credit report for up to seven years.
- Collection: After a charge-off, the original creditor may sell the debt to a third-party collection agency. This agency buys the right to collect the debt for a fraction of its value. A new tradeline from the collection agency then appears on your credit report. It's possible to have both the original charge-off and the collection account listed for the same medical event.
For mortgage qualification purposes, there is virtually no difference in how medical charge-offs and medical collections are treated. The same lenient FHA and Conventional guidelines apply to both. They are excluded from DTI calculations and do not need to be paid off.
Do I need to pay off all medical debt before I can close on my home?
For the vast majority of homebuyers, the answer is a clear and resounding no. You are not required to pay off outstanding medical collections or charge-offs to be approved for a mortgage or to close on your home.
An underwriter's primary concern is your ability and willingness to make consistent, on-time mortgage payments. The current rules reflect the understanding that past medical debt is not an indicator of future mortgage performance.
The only rare exception would be if an unpaid medical debt has resulted in a judgment or a lien filed against your assets. A judgment is a court order that must be addressed, but a simple collection account on your credit report does not require action.
If a collection is in dispute, how does that affect my mortgage application?
Placing an account 'in dispute' with the credit bureaus can halt a mortgage application. Lenders need a clear, undisputed picture of your credit liabilities. However, medical collections once again get special treatment.
- FHA Loans: FHA guidelines on disputed accounts can be complex, but generally, medical collections are not an obstacle in the same way non-medical collections are. (The data, information, or policy mentioned here may vary over time.)
- Conventional Loans: Rules can be stricter. If the cumulative total of all disputed derogatory accounts (including non-medical) exceeds a certain threshold, the underwriter may require you to remove the dispute status before proceeding. (The data, information, or policy mentioned here may vary over time.)
Best Practice: To ensure the smoothest and fastest process, it is highly recommended to contact the credit bureaus and have the 'in dispute' notation removed from all accounts before you formally apply for a mortgage. This eliminates any potential for delays or underwriting conditions.
What is the best way to address medical debt with my loan officer?
Transparency and strategy are your best tools. Hiding from the issue will only cause problems later. Use this simple, three-step approach.
- Disclose Everything Upfront: In your very first conversation, tell your loan officer about any medical collections you are aware of. This allows them to set proper expectations and structure your loan file correctly from day one.
- Follow Their Lead: Your loan officer understands the specific underwriting guidelines for your chosen loan program. Do not pay off any debts, send any letters, or contact any collection agencies without their explicit instruction. Acting on your own can sometimes make the situation worse.
- Provide Documentation if Asked: If you have paperwork showing a payment plan or that insurance is handling a bill, keep it organized and ready. The underwriter may ask for a letter of explanation for very large or recent collections, and being prepared will speed up the process.
Navigating a home purchase with medical debt can feel complex, but you don't have to do it alone. If you're ready to see how these modern guidelines can work for you, take the first step toward clarity and confidence. Apply now to get a personalized assessment of your situation and discover your path to homeownership.
Author Bio
David Ghazaryan is the expert mortgage strategist and founder behind iQRATE Mortgages. With a mission to fund home loans that traditional banks won't touch, David specializes in helping clients with unique financial situations, including those recovering from foreclosure or bankruptcy. He expertly crafts smart, strategic, and stress-free mortgages by leveraging a vast network of over 100 lenders to secure competitive rates for investors and homebuyers alike. Praised for exceptional customer service, David has helped hundreds of families with a 97% satisfaction rate, guiding them to the mortgage they deserve.
References
CFPB: Medical debt on your credit report
Fannie Mae Selling Guide: Credit Assessment
HUD Handbook 4000.1: FHA Single Family Housing Policy Handbook
