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Homeownership After a Short Sale

urlAfter the financial crisis of 2008, millions of homeowners throughout the U.S. fell underwater on their mortgage loans, meaning that the remaining balance on their mortgage was more than the actual value of the home.  Many homeowners did not have much choice but to participate in a short sale, or sell their home for a value less than.  In the eyes of a lender, this is not one of the best things to have on a prospective buyer’s record, but also not the worst as the lender does still recover some of their funds.  All is not lost for these homebuyers, and what many past short-sale participants don’t know is that there is still a chance out there for them to achieve the American Dream of home ownership, even shortly following the short sale.

The ideal situation for a prospective homebuyer with a short sale on record is that the credit has been well taken care of since the sale, all bills have been paid on time over the past 12 months, and plenty of money has been saved for a down payment.  The best way to establish good credit is to pay all bills on time, and keep credit balances low to minimize debt.  Also, any inaccuracies on the credit report should be taken care of in order to optimize the credit score.  This step is absolutely essential after a short sale.

Very often, short sales are recorded as “foreclosures” on credit reports, which is much more detrimental to the credit scores than short sales, and make it significantly harder to obtain a new mortgage.  Foreclosures look worse on the credit report because they demonstrate that the previous lender had to use legal action to take ownership of the home after the borrower missed payments on their mortgage.  With a foreclosure on the credit report, the lender may deny the application because either the credit score is too low, or a longer post-foreclosure waiting period must be applied for the applicant, as the standard waiting periods are typically longer after a foreclosure as opposed to a short sale.  When there is a foreclosure on the credit report, an accepted mortgage application can be worse than a denied application in some cases as the lender might require the borrower to make a higher down payment with a higher interest rate than what would have been required if the short sale were properly recorded by the credit reporting agencies.  In order to make sure that the inaccuracies are amended, contact all three major credit reporting agencies and supply all documentation of the short sale to them.

Just like advice given to any prospective buyer before making a home purchase, avoid taking out car loans or making credit card transactions.  Prospective homebuyers should free up as much access to credit as possible. Typically, putting 20% down or more is the best situation to be in as it allows prospective buyers to buy a home sooner after the short sale while also avoiding mortgage insurance, which can be expensive.  Of course, borrowers must income qualify as well.  The process of getting back into a home loan varies depending on the lender, the loan type, the amount being used for a down payment, and the applicant’s financial standing.

Under certain circumstances, there is no waiting period for an FHA-insured mortgage loan after a short sale, according to Nolo.com.  The requirements to be met for no waiting period are that the borrower did not default on the prior mortgage at the time of the short sale, and all of the mortgage payments on the previous loan (as well as other debt payments) were on time for 12 months before the date of the short sale, as long as it does not appear that the borrower was taking advantage of the mortgage market and attempting to purchase the same kind/size of home in the same proximity of the home that was short sold.  If the borrower did default on the previous mortgage at the time of the short sale, the waiting period is either 3 years after the date of the short sale or 3 years after the date that the FHA paid the short sale claim (given that it was definitely an FHA-insured loan). The only exception to this 3-year rule is if the borrower had extenuating circumstances and can prove it with the appropriate documentation.  In this case, the wait would be less than 3 years for said borrower, and the new mortgage could potentially be attainable immediately after the short sale.  This can apply despite defaulting on the previous mortgage.  However, it is ideal to be able to put down the highest down payment possible, which may take time.

The FHA requires that a significant amount of proof be provided for extenuating circumstances.  Hardships such as job loss, catastrophic medical bills, death of the primary wage earner in the family, and divorce (in limited situations) must be documented.  These can be proven with tax returns, W2s, Verification of Employment, bills preceding the short sale, or receipt of unemployment income.  Other examples of extenuating circumstances include significant increase in financial obligations such as mortgage payments. The FHA also wants to know that the prospective homebuyer has demonstrated full recovery from the event and has completed housing counseling under the HUD Counseling Agency with a certificate of completion.  ILoanHomeMortgage.com defines a “full recovery” as “the borrower’s credit history is clear of late housing or installment debt payments, and major derogatory credit issues on revolving accounts; and any open mortgage is current and shows 12 months satisfactory payment history”.  The FHA requires documentation to prove that the proceeds from the short sale served as payment in full, and also that the short sale took place at least 12 months ago.  To find out the exact waiting period one must fulfill after a short sale, refer to the mortgage insurance claim and when it was paid on the prior mortgage.

The waiting period requirements for Fannie Mae and Freddie Mac differ from the FHA guidelines.  These investors primarily focus on how much money the borrower is able to put down for the new mortgage.  Fannie Mae and Freddie Mac require a 2-year waiting period if the borrower is able to put 20% down, a 4 year waiting period if the borrower is able to put between 10% and 19.9% down, and 7 years if the borrower puts less than 10% down and is consistent with Fannie Mae’s eligibility matrix, which can be found here.  The waiting period may be able to be shortened to 2 years for either Fannie or Freddie if the borrower can prove with supporting documentation that the short sale was a result of extenuating circumstances, and that the borrower can put 10% down.  The 2-year rule is also applicable for VA mortgages and 10% down according to Zillow.  In order to obtain Fannie or Freddie loans, applicants must shop with approved Fannie Mae/Freddie Mac lenders.  Broadview Mortgage is an approved lender of Fannie Mae and Freddie Mac.

For an overview of the loan types, their waiting periods, and requirements, refer to the chart below:

Loan Type Waiting Period Requirement(s)
FHA No waiting period -borrower did not default on prior mortgage at the time of short sale-all mortgage payments on previous loan & other payments were on time for 12 months before the short sale

-borrower did not take advantage of the mortgage market  at the time

  3 year -borrower did default at the time of short sale
  Under 3 year -borrower can prove extenuating circumstances
Fannie Mae/Freddie Mac 2 year -borrower can put 20% down, or-VA mortgage with 10% down
4 year -borrower can put between 10 and 19.9% down
7 year -borrower can put less than 10% down

The change in the marketplace has prompted Forbes to add new terms to our vocabulary, referring to these types of homebuyers as “boomerang buyers”. Forbes defines boomerang buyers as persons who have owned a home, seen the benefits, have been pushed out of homeownership for one reason or another, and are now ready to get back into the market.  Forbes contends that since the FHA has minimized the waiting period from 36 months to 12 (or even less), nearly 2.5 million additional homeowners could potentially enter the market as boomerang buyers in addition to the 4.3 million+ homebuyers who went through foreclosure or short sale between September of 2007 and August 2010.  The article brings up an interesting point that the burst of the housing bubble led to the onset of “now an entire multi-billion dollar industry… devoted to renting single family homes to many of these former homeowners…if significant numbers of boomerang buyers are unable or unwilling – or both – to go through this door that has been opened a little wider for them, the more likely we’ll see a longer-term paradigm shift toward a renter nation”.  This paradigm shift may be due to highly cautious former homeowners now afraid of the housing market, or it may also be due to the lack of knowledge of their possible ability to buy again and when they can begin.

 

 

 

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