Medical Debt and Mortgage Approval for Kentucky Homebuyers
Medical debt has long been a challenge for many Americans. It particularly affects credit scores and the ability to secure a mortgage loan. Fortunately, the Consumer Financial Protection Bureau (CFPB) has finalized a new rule. This rule is set to remove medical debt from consumer credit reports. As a result, more opportunities may open up for homebuyers in Kentucky. Here’s how this change can affect your mortgage approval process. Also, understand what you need to know about medical debt and credit scores in Kentucky.
What’s Changing with Medical Debt and Credit Reports?
The CFPB has implemented a new rule to remove medical debt from credit reports. This change is significant for borrowers in Kentucky. Medical debt often lowers credit scores. It creates hurdles in the mortgage approval process.
Here’s what to expect from the new rule:
Implementation Timeline: The rule is expected to take effect in at least 60 days.
Debt Removed: Over $49 billion in medical debt will be erased from credit reporting systems.
Consumer Impact: An estimated 15+ million Americans will see their credit reports improved.
Credit Score Boost: Consumers affected by this change could see an average credit score increase of 20 points.
Mortgage Approvals: This change is anticipated to result in over 22,000 additional mortgage approvals annually across the U.S.
How Medical Debt Affects Credit Scores in Kentucky
Before this rule, unpaid medical bills often appeared on credit reports, negatively impacting credit scores. In Kentucky, this has been a common issue for homebuyers trying to secure mortgage loans.
Key Effects of Medical Debt on Credit Scores:
Lower Credit Scores: Medical debt can drag down your FICO score, making it harder to qualify for favorable loan terms.
Higher Interest Rates: A lower score often leads to higher interest rates on mortgages.
Mortgage Denials: In some cases, excessive medical debt could result in outright denials of loan applications.
Even with medical debt on your report, mortgage lenders may consider compensating factors. These factors include stable income, down payment assistance, or other positive financial attributes.
How Credit Scores Impact Mortgage Loan Approval in Kentucky
Mortgage lenders in Kentucky use credit scores as one of the primary factors to determine loan eligibility. Here’s how it works:
Credit Score Requirements by Loan Type:
FHA Loans: Minimum credit score of 580 with a 3.5% down payment. Scores as low as 500 may be considered with a 10% down payment.
Conventional Loans: Minimum credit score of 620 or higher.
VA Loans: No minimum credit score set by the VA, but most lenders prefer a score of 580-620.
USDA Loans: Minimum credit score of 640 for automatic approval, though manual underwriting is possible for lower scores.
Impact of Credit Score on Interest Rates: Higher credit scores lead to better mortgage rates. Lower scores can result in higher monthly payments.
Debt-to-Income Ratio (DTI): Lenders calculate your DTI to ensure you can manage your mortgage payments alongside other debts. Medical debt previously factored into this calculation, potentially increasing your DTI and reducing your borrowing power.
Last updated October 2026 by Joel Lobb, Kentucky FHA mortgage broker (NMLS #57916).
Short answer: No. FHA does not require every collection account to be paid off before you can buy a home in Kentucky. What matters is the total balance of your non-medical collections, whether the loan gets an automated approval or has to be manually underwritten, and how the collections affect your debt-to-income ratio (DTI).
What Counts as a Collection Account?
A collection account is a debt the original creditor turned over to a collection agency, or sold to one, after you stopped paying. Common examples are old credit cards, cell phone or utility bills, apartment balances, and medical bills. Collections stay on your credit report for up to seven years from the original delinquency, even after they are paid.
The $2,000 Rule for FHA Collections
FHA looks at the cumulative (combined) balance of all non-medical collection accounts on your credit report:
Total non-medical collections
What FHA requires
Under $2,000
No payoff required and nothing added to your DTI. The lender may still ask for an explanation, especially on a manual underwrite.
$2,000 or more
The lender must use one of three options (below).
When your combined collections are $2,000 or more, the lender must do one of the following:
Pay them off: verify the collections are paid in full before or at closing, using an acceptable source of funds.
Payment plan: verify you have a payment arrangement with the creditor and count that monthly payment in your DTI.
5% rule: if no payment arrangement is available, count 5% of the outstanding balance of each collection as a monthly payment in your DTI.
Unless the lender uses the 5% calculation, you will need documentation: proof of payment in full, a payoff statement if the collection is paid at closing, or the written payment arrangement.
Example: How the 5% Rule Affects Your DTI
Say you have $3,000 in non-medical collections and no payment plan. The lender counts 5% of $3,000, or $150 a month, as a debt, even though you are not actually making that payment. On a $4,000 monthly income, that $150 adds almost 4 percentage points to your DTI. If that pushes you over the limit, paying off a smaller collection or setting up a lower payment plan before you apply can make the difference.
Medical Collections Do Not Count
Medical collections are excluded from the $2,000 calculation. You do not have to pay them off, and they are not added to your DTI. A borrower with $5,000 in medical collections and $800 in other collections is treated as having only $800, which is under the $2,000 threshold.
Charge-Offs Are Treated Differently
A charge-off is a debt the creditor has written off as a loss. FHA does not require charged-off accounts to be paid, and they are not included in your DTI. On a manually underwritten loan, the underwriter may still ask you to explain them.
Disputed Accounts Can Trigger a Manual Underwrite
Disputing old collections to raise your score can backfire. If your credit report shows disputed derogatory accounts totaling $1,000 or more, an automated FHA approval must be downgraded to a manual underwrite, which has stricter DTI limits and documentation. These disputes do not count toward the $1,000:
Disputed medical accounts
Accounts with a zero balance
Accounts with no activity in the last 24 months
Accounts disputed because of identity theft or unauthorized use, when documented
Tip: talk to a loan officer before you dispute anything on your credit report while you are getting ready to buy.
Judgments Must Be Resolved
Court-ordered judgments are stricter than collections. A judgment must either be paid off before or at closing, or you need a written payment agreement with the creditor and proof of at least three months of on-time payments. You cannot prepay those three months to get around the rule. The judgment payment is also counted in your DTI.
Federal Debt, Student Loans in Default, and CAIVRS
Every FHA borrower is checked against CAIVRS, the federal database of delinquent government debt. A defaulted federal student loan, an unpaid prior FHA or VA claim, or other delinquent federal debt makes you ineligible until the debt is brought current or resolved, for example through a rehabilitation or repayment agreement. This is the one type of collection that can stop an FHA loan no matter how small the balance is. If your student loans are in collections, read Student Loans in Collections: What Can I Do to Get Approved?
Manual Underwriting and Collections
If your loan does not receive an automated “Accept,” it is manually underwritten and collections get a closer look. The underwriter must determine whether the collections came from:
Disregard for financial obligations,
Inability to manage debt, or
Extenuating circumstances, such as a job loss, medical emergency, or divorce.
You will need a signed letter of explanation for each outstanding collection, backed by documentation that matches the rest of your credit file. Learn more in Kentucky FHA Manual Underwriting Guidelines.
Kentucky Is Not a Community Property State
In community property states, a non-borrowing spouse’s collections must be counted toward the $2,000 total. Kentucky is not a community property state, so if you buy in Kentucky without your spouse on the loan, their collections are not counted.
Should You Pay Off Collections Before Applying?
Not always. Paying an old collection does not remove it from your report, and it usually does little for your credit score. Before you pay anything, have a loan officer look at your actual credit report. Often the best move is to:
Pay off just enough small collections to get your non-medical total under $2,000,
Set up a payment plan that costs less each month than the 5% calculation, or
Leave the collections alone if your DTI still qualifies, and keep your cash for your down payment and closing costs.
Keep in mind that individual lenders can have stricter rules (“overlays”) than FHA’s minimums. That’s one reason working with a broker who can shop multiple lenders helps when your credit has collections.
Can I get an FHA loan with collections on my credit report?
Yes. Collections alone do not disqualify you. If your non-medical collections total less than $2,000, they generally do not need to be paid or counted in your DTI.
Do medical collections affect an FHA loan?
No. Medical collections are excluded from the $2,000 calculation and are not added to your DTI.
What is the 5% rule for FHA collections?
If your non-medical collections total $2,000 or more and you are not paying them off or on a payment plan, the lender counts 5% of each collection’s balance as a monthly payment in your DTI.
Do judgments have to be paid for an FHA loan?
Yes. A judgment must be paid off, or you need a written payment agreement and at least three months of documented on-time payments.
Get Your Credit Reviewed Before You Apply
If you have collections and want to know whether you qualify for a Kentucky FHA loan, send me a message. I’ll review your credit report and tell you exactly what, if anything, needs to be paid before you apply.
Joel Lobb Mortgage Broker – FHA, VA, USDA, KHC EVO Mortgage 10602 Timberwood Circle, Suite 3, Louisville, KY 40223 Call/Text: (502) 905-3708 Email: kentuckyloan@gmail.com NMLS #57916 | Company NMLS #1738461
Source: HUD Handbook 4000.1, Sections II.A.4.b.iv and II.A.5. This is not a commitment to lend. All loans are subject to credit approval, underwriting guidelines, and lender requirements, which may change. Equal Housing Lender. Licensed in Kentucky only. Not affiliated with HUD, FHA, or any government agency.
