A bankruptcy judge has rejected Countrywide Financial Corp.'s proposal to settle accusations that it fabricated evidence used in a bid to foreclose on a home, saying he wants to know more about the alleged false documents.

Judge Thomas Agresti of the U.S. Bankruptcy Court in Pittsburgh on Tuesday dismissed the company's request to settle a dispute with Sharon Diane Hill, a Pittsburgh-area woman who was threatened with foreclosure by the country's largest home lender.

Ms. Hill was up to date on her payments, but Countrywide threatened to take her home if she didn't pay thousands more in fees, according to court documents. It later backed off and offered to pay her lawyers. But Ms. Hill said her credit was permanently marred by the foreclosure attempt.

Details of the settlement proposal were filed under seal, which Judge Agresti said was unjustified. He also said the settlement documents were deficient because they failed to reveal what Ms. Hill's lawyers found out about the alleged fabricated evidence.

Countrywide, to demonstrate that Ms. Hill had been late on her mortgage payments, sent letters to her attorney that were dated Sept. 22, 2003, Oct. 25, 2004, and March 29, 2007. The letters referred to changes in escrow requirements that showed she was delinquent on her loans.

But the attorney said he never received the letters and was able to show in court that the letters were phony. Countrywide later said one of its technicians "recreated" them electronically. Bankruptcy-court officials demanded a full investigation, and Judge Agresti authorized it.

On Tuesday, Judge Agresti said he wouldn't approve a settlement until he got to the bottom of Countrywide's suspected forgeries. He said he was concerned about "the potential effect that a settlement in this case may have in other cases involving Countrywide."

A spokesman for Countrywide didn't respond to a request to comment.

In hearings before U.S. lawmakers Tuesday, the head of Countrywide's loan-servicing division, Steve Bailey, said that "on occasion, employees in Countrywide's bankruptcy-servicing department make mistakes." But he denied the company has intentionally abused homeowners.

Write to Peg Brickley at peg.brickley@dowjones.com

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