Unfortunately, many Americans need to deal with adverse issues on their credit reports and they wonder how these negative issues will affect their financial futures. As such, people often ask me: Ryan, will a charge off affect buying a house?
Yes, a charge off on your credit report will absolutely affect your ability to buy a house. This demonstrates a debt that some lender has deemed uncollectable. When mortgage lenders see a charge off, they assume you cannot be trusted as a borrower. To buy a home, you need to remove the charge off.
I’ll use this article to explain more about how charge offs affect the homebuying process. Specifically, I’ll dive into the following topics:
- What is a Charge Off?
- Will a Charge Off Affect Buying a House?
- Buying a Primary Residence with a Charge Off
- Buying an Investment Property with a Charge Off
- Removing a Charge Off from Your Credit Report
- Alternatives to Buying a House with a Charge Off
What is a Charge Off?
A charge off relates to a debt that you owe to some lender. If you owe money, the lender will make efforts to collect that money. This collection period typically involves a series of “past-due” notices. While lender collection policy varies, borrowers can expect to receive 30-, 60-, 120-, and, finally, 180-day past-due notices.
Eventually, the lender will assume that your debt has become uncollectible. In other words, the cost of trying to track you down doesn’t outweigh the potential funds recovered. When lenders reach this point, they write off your debt. This is a tax/accounting technique that removes the debt balance from the lender’s books. And when a lender does this, it appears as a charge off on the borrower’s credit report. Charge offs can last on a borrower’s credit report for up to seven years.
Of note, when you receive a charge off, you still owe that money. All this means is that the original lender has stopped pursuing you. However, rather than accept a complete loss, many lenders choose to sell or assign this debt to collection agencies. When this happens, you now owe the collection agency the original balance. These organizations tend to be far more aggressive in their collection efforts. For borrowers, this means that a charge off can create two major problems: 1) an adverse credit report item, and 2) a collection agency pursuing you. In certain situations, a charge off can also result in a judgment against you or a lien on your property.
Will a Charge Off Affect Buying a House?
Yes, a charge off will absolutely affect your ability to buy a house. To understand why, people need to view a charge off from a potential lender’s perspective.
Assume you want to buy a home. This is a major purchase—generally the largest one people make in their lifetime. Accordingly, it requires a major loan. And banks don’t lend these funds lightly. They’ll go through your credit history and financial information with a fine-toothed comb. Simply put, they want to ensure that you can and will repay your mortgage loan.
With this in mind, when lenders see a charge off on your credit report, it tells them you’re an unreliable borrower. Unfortunately, credit reports don’t reflect all the difficult situations in your personal life that led to the charge off. They only reflect a borrower’s failure to repay a past debt, and that means future lenders likely won’t lend to you. Borrowers with charge offs just pose too much risk to lenders, so they typically won’t approve you for a mortgage.
With that said, different considerations exist for buying different types of houses. In the next couple sections, I’ll talk about buying both primary and investment properties with a charge off.
Buying a Primary Residence with a Charge Off
Realistically, most lenders will not issue borrowers with charge offs a home loan. For the above reasons, these borrowers just pose too much of a collection risk.
However, lenders generally consider borrowers buying a primary residence more reliable than ones buying an investment property. In theory, someone struggling to repay debts will pay the mortgage covering their head before paying the investment property one. For this reason, some options exist to receive a home loan, despite this adverse credit history.
In particular, the Federal Housing Administration, or FHA, provides guidance on situations when borrowers with charge offs should still qualify for an FHA-backed loan. In theory, this provides a path to homeownership for these people.
But, lenders can impose stricter requirements—known as overlays—than the FHA. As a result, even if someone meets FHA criteria to purchase a home, the lender doesn’t need to approve your mortgage application. Despite this, there are lenders who will, in certain situations, approve loans for borrowers with charge offs on their credit reports. These lenders are few and far between, though.
Buying an Investment Property with a Charge Off
What about buying investment properties? Realistically, investors have no options to get an investment property loan with a charge off in their pasts.
As hard money lenders, we don’t base our loan decisions on an investor’s “soft assets”—income, credit report, debt-to-income ratio, etc. Instead, we’re primarily concerned about the “hard asset”—the property—and whether it represents a good deal. As such, we generally don’t have issues providing loans to investors with bad credit scores.
However, when it comes to judgments, charge offs, and bankruptcies, hard money lenders will not provide loans. These adverse credit items undermine a borrower’s reliability. If someone failed to repay a debt in the past, hard money lenders assume that there’s a chance he or she won’t repay an investment property loan, too.
And unlike the FHA exceptions for primary residence loans, no realistic path to an investment property loan exists. Real estate investors just can’t expect to find a way to get a loan for an investment property with a charge off on their credit reports.
Removing a Charge Off from Your Credit Report
Clearly, charge offs seriously hurt your chances to buy a house. This means that people should focus all of their efforts on removing charge offs from their credit reports. And, a couple options exist to do this.
First, you can call the lender directly and negotiate a repayment. Most lenders prefer getting something rather than nothing. As a result, many lenders will accept repayments significantly smaller than the original debt. I personally recommend borrowers proposing 10% repayment. So, if you owe $5,000, call and ask if the lender will accept $500 as repayment. But, the key here is that lenders need to accept this as payment-in-full—not just a partial repayment of the whole balance. If lenders agree, your charge off will be removed from your credit report.
Second, borrowers can hire a credit repair agency. While this costs money, these companies may be able to more effectively negotiate debt settlements. Or, if a charge off was mistakenly applied, credit repair agencies have a ton of experience fixing these mistakes.
Alternatives to Buying a House with a Charge Off
Buying a house is certainly challenging—if not impossible—with a charge off on your credit report. Fortunately, alternative paths exist for real estate investors. With a wholesaling strategy, investors don’t need to qualify for loans, so charge offs don’t matter. And, you can use the profits from this strategy to gradually pay down debt and improve your credit score.
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