How does FHA treat charge offs?

Charge-off accounts are not required to be paid off before closing under FHA guidelines and are excluded from the DTI calculation under both AUS and manual underwriting paths. However, underwriters must analyze the cause of recent charge-offs and, on manual underwrites, document a borrower explanation.

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Agency Guideline Requirements (FHA Handbook 4000.1)

Definition: A Charge Off Account is "a Borrower's loan or debt that has been written off by the creditor."

DTI Treatment

• Charge-offs are excluded from the monthly debt calculation under both TOTAL Scorecard and manual underwriting paths.
• Under Manual Underwriting: "Charge Off Accounts do not need to be included in the Borrower's liabilities or debt." Nations Direct
• Payoff at closing is not required by FHA agency guidelines.

Credit Analysis Requirement

• The Lender must determine if Charge Off Accounts in the past 24 months were a result of: the Borrower's disregard for financial obligations; the Borrower's inability to manage debt; or extenuating circumstances.
• The Lender must document reasons for approving a Loan when the Borrower has any Charge Off Accounts in the past 24 months. The Borrower must provide a letter of explanation, which is supported by documentation, for each outstanding Charge Off Account. The explanation and supporting documentation must be consistent with other credit information in the file.
• Note: The LOE and cause-analysis requirement is a manual underwriting trigger. Under TOTAL Scorecard: "The Mortgagee is not required to obtain an explanation of collection accounts, Charge Off Accounts, accounts with late payments, Judgments or other derogatory information." The LOE requirement is waived at the agency level for AUS approvals.

Disputed Charge-Off Accounts

• A disputed charge-off is treated as a "Disputed Derogatory Credit Account."
• If the borrower has $1,000 or more collectively in disputed derogatory accounts (including disputed charge-offs), the mortgage must be downgraded to a Refer and manually underwritten.
• Exclusions from the $1,000 cumulative balance: disputed medical accounts and accounts resulting from identity theft.

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Lender Overlays / Matrix

Nations Direct

• "Charged off accounts do not need to be included in the debt. Repossessions are treated as charge-offs unless specifically notated that the account was sent to collections. Guidelines for collections are followed in those instances." Nations Direct Nations Direct
• Note: If a repossession is reported as sent to collections, collection account rules apply instead of charge-off rules.

JMAC Lending

• "Charge Offs: TOTAL Scorecard approved: Per AUS approval. Manual underwriting: There can be no charge offs in the most recent 12 months." JMAC Lending
• On FHA Streamline: "All charge offs must be seasoned at least 12 months, or extenuating circumstances must be documented." JMAC Lending
• Overlay: JMAC imposes a 12-month seasoning requirement on manual underwrites and streamlines — stricter than the base FHA guideline.

Mega Capital

• "Collection accounts, if the combined cumulative balance on all the collections accounts exceed $2,000 or greater the following will apply: Count 5% of balance as payment, or Payoff Collections, or Provide copy of established payment plan with credit agency and verify minimum payment. Note: Medical Collections and Charge-Offs are excluded." Mega Capital
• Charge-offs are explicitly excluded from the $2,000 collection payoff threshold at Mega Capital.

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Quick-Reference Matrix