You usually do not have to pay off collections to refinance, but it depends on your loan type and on the total. Conventional loans often close with collections still open. FHA starts asking questions once nonmedical collections reach $2,000. Medical collections get gentler treatment almost everywhere. Freddie Mac's survey put the 30 year fixed rate at 7.32% on October 22, which means you cannot afford to waste cash on a payoff that does nothing for your approval.

What the rules say, by loan type

The rules differ by program, and lenders sometimes add their own stricter ones. This table is a general guide for homeowners in Scottsdale, Phoenix, and across the Valley. Your lender's guidelines control.

The U.S. Department of Housing and Urban Development publishes the FHA guidelines lenders follow. Fannie Mae and Freddie Mac publish the conventional ones. If a lien or judgment is involved, read our post on refinancing with a lien or judgment first.

Medical debt gets different treatment

Medical collections are the easiest ones to live with. FHA leaves them out of the $2,000 test. The three national credit bureaus have said they no longer report medical collections under $500, and paid medical collections come off a report. The Consumer Financial Protection Bureau explains your rights when a collector contacts you and how to ask for proof of a debt.

Look at the bill before you pay it. Medical billing has errors, and insurance sometimes pays late. Ask the collector to validate the debt in writing. If it is wrong, dispute it with the bureaus. If it is right, ask what a paid in full letter will cost you.

The debt to income math

The real damage from a collection is often a number, not a score. If your loan type counts a payment, your debt to income ratio rises. Here is an example with $8,000 of monthly income and $2,800 of monthly debts, plus a $4,000 collection that a program counts at 5% of the balance, or $200 a month.

That 2.5 point swing could be the difference between an approval and a counteroffer. It also means paying $4,000 can be the cheapest fix if you are right at a limit, and a waste if you are not. Our guide to the debt to income ratio lenders allow shows where the lines sit.

Run your own numbers

When paying it off is worth it

Pay it when it clears a hard requirement or moves you past a line, and not when it only soothes your nerves. Three cases come up often: your program requires payoff, a payment would push your ratio over the limit, or your cash out refinance can retire the collection at closing for free. Our post on the credit score you need to refinance explains how scores factor in.

Skip it when the lender does not require it, when the cash would drop your reserves below what you need, or when the account is very old. Paying an old collection can sometimes restart how the creditor treats it. Ask your loan officer, and ask a lawyer if the amount is large, before you send money.

Using a cash out refinance to clear it

A cash out refinance can pay collections at closing, and the lender can send the funds straight to the collector. That only works if the loan qualifies on its own. Closing costs run higher on a cash out, so read our guide to refinance closing costs in Arizona before you commit. Expect a higher rate than a plain rate and term refinance, and do the math on your new payment first.

The Internal Revenue Service explains how federal tax liens work if the debt you are dealing with is owed to the IRS. Those do not behave like ordinary collections.

What not to do while you wait

Do not open new accounts, do not take out a loan to pay a collector, and do not ignore a notice about a lawsuit. A court judgment is a bigger problem than the collection was. Keep your payments on time, since a fresh late payment hurts more than an old collection. Our post on refinancing with late mortgage payments covers that situation.

A simple plan, in order

Start by pulling your reports. Then sort each item as medical, nonmedical, lien, or judgment. Then call your loan officer with the totals and get the rule for your loan type in writing. Only then decide whether to pay. If a scoring fix is part of the plan, ask about a rapid rescore, which your lender orders after a documented change.

What to send your lender

Send the collection letter, the original creditor's name, the balance, and any proof of payment or dispute. If the debt is medical, add the bill and the insurance explanation of benefits. Lenders want to see that you know what the account is and that you have a plan for it. A one paragraph letter of explanation helps if the debt came from a job loss, an illness, or a divorce. Keep it factual, keep it short, and do not guess at dates.

Bring your last two months of bank statements too. If you plan to pay a collector, the lender will want to see where the money came from. A gift or a large deposit with no paper trail can cause a delay of its own. Homeowners in Scottsdale and across the Valley who also track the market can read the Homes.com Phoenix housing market report to see how much equity a cash out might have available.

Where we fit in

We review collections and medical debt for refinances in Scottsdale, Phoenix, and across Metro Phoenix. See the loan programs we offer, how our process works, and who you will talk to on Blake Hermann's page. If you are also thinking about a move, search homes on Arizona Luxury Property Search. You can also start at pillarmortgagegroup.com.

Frequently asked questions