Financing a home after experiencing a short sale or a foreclosure can be a daunting process yet not impossible.
However without proper guidance, potential buyers can be disappointed when their loan application is turned down, not necessarily because of a short sale or foreclosure but simply because they applied for the wrong type of home loan.
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This isn’t the buyer’s fault, it’s the loan officer at the mortgage company who didn’t understand lending guidelines in the first place. Mortgages can have some rather strict guidelines as it relates to either event and they’re hard to overcome. Impossible in most cases. If a guideline states a borrower must wait at least seven years before being eligible once again for a conventional loan while also reestablishing credit with at least three trade lines, well, it is what it is and there’s not too much the borrowers can do. That is unless the borrowers are guided to the proper loan in the first place. Before we get too much further in the loan details, let’s first review the mechanics of both a short sale and a foreclosure to understand how a mortgage lender treats either of these unfortunate events.
A short sale, by definition, is the sale of a property where the lender accepts less than what is owed on the mortgage as paid in full. Take a homeowner who purchased a home in say 2005 and paid $500,000 for it and put 10% down. Over the next few years the real estate market experienced a huge downturn and property values fell dramatically. The homeowner then decides to take the loss and sell the property and move on. But the homeowner can’t.
Not because the list price is too high but because the homeowner owes more on the mortgage than the home is worth.
Using this scenario, let’s assume the current mortgage balance is now $450,000 but the property is worth $400,000. A real estate agent prepares a market study and comes to the conclusion the home would sell, as is, for $395,000. The homeowner is also presented with a “net sheet” by the real estate agent that identifies the selling costs involved from the home that would be deducted from the sale. These costs include a 5.0% commission to the real estate broker, title insurance, settlement fees and other related costs for a total of $25,000. If the homeowner was not “upside down” with the mortgage the $25,000 would be deducted from the selling price and the homeowner would get the rest. Yet this won’t happen because the mortgage balance alone is $55,000 higher than what the agent feels the home will sell for.
Just to pay off the existing mortgage means bringing in another $55,000 to satisfy the lender in addition to the selling costs of $25,000 for a total of $80,000. That’s how much the homeowner would have to write a check for just to sell the property and the homeowner has nowhere near that amount. In fact, the homeowner is unemployed and in danger of losing the home to foreclosure. The homeowner is stuck.
Now enter the short sale.
Lenders will grudgingly accept a short sale request but only if the lender concludes there is no other alternative other than to foreclose on the property. Foreclosures are expensive for lenders and if the lender in this example did reclaim the property, the lender would lose even more due to the legal expense, selling costs and current market conditions. Qualifying for a short sale is more than just calling up the bank and asking if it’s okay to pay less than what is owed. Instead, the lender must document the current situation and explain why a short sale may be the best alternative.
First and foremost, the homeowner needs to document a hardship that is beyond the homeowner’s control. A qualifying example might be a job transfer to another city or even the loss of a job. A couple getting a divorce and wanting to sell the home is another. Second, the lender wants to know if this is a short term situation or one that could linger for quite some time.
The lender will also review the owner’s current financial situation. The owner then provides recent bank and investment statements showing how much cash is available. If the owner is underwater by $55,000 and the bank statements show $50,000 in the bank, the short sale request will be denied. If there are little to no funds available, the lender would then consider a short sale request. In fact, in this example where the owner is unemployed now and for the foreseeable future and there are no funds available to satisfy the mortgage, the lender would probably approve the short sale.
A buyer is found, the closing takes place and the outstanding mortgage is satisfied, releasing the owner from any future liability. Finally, how does a future lender know there was a short sale in a borrower’s past? The credit report will read something to the effect of, “Settled for less than owed” next to the old mortgage. This tells the lender the owner experienced an extended financial hardship and will be subject to greater scrutiny when applying for a new loan. So much scrutiny that, depending upon the loan, a borrower must wait at least four years before qualifying for a mortgage after a short sale event.
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Perhaps the worst thing a borrower can do as it relates to being approved for a mortgage is having a previous home loan go into foreclosure. A foreclosure is the last resort for a lender and is a costly, lengthy process. Some mistakenly think that some lenders will make a loan to those with shaky credit only to take the property back a short time later due to nonpayment. This is far from the case. When lenders foreclose, they’ve already lost thousands.
Lenders must follow strict guidelines before a foreclosure can take place. Just because a homeowner misses a payment, even two in a row, the lender can’t take back the home. California is called a “non-judicial” foreclosure state because the lender doesn’t have to sue and appear in court before a judge. Lenders are allowed to file a Notice of Default after the borrowers miss two payments in a row, although some Notices are sent when the borrowers are four, five or even six months past due. The Notice is sent via certified letter and shows the borrower how much is needed to bring the loan current and stop the foreclosure process. The lender must then wait at least 60 days before taking the next step—selling the home at an auction. This entire process takes at least 120 days and longer if the borrowers contest the foreclosure action.
During this period, the lender and the borrowers can work out other agreements such as a loan modification where the lender changes the terms of the mortgage that adjust to the borrowers current financial situation. The lender might adjust the term of the note, lowering the monthly payment or reduction the interest rate on the loan. In either instance, the borrowers must be able to demonstrate the ability to repay the reduced payment. If the borrowers are unemployed or do not make enough money each month to pay the new mortgage in addition to current debt and expenses, it’s very likely the lender will proceed. However, as long as the owners are making a good faith effort to recover from their financial difficulties and can show the lender the bad times are only short-lived, a recovery can be made. A foreclosure is a last resort for a lender. A lender would rather work something out with an owner instead of foreclosing, especially in areas where foreclosure and depressed home values are the norm. In addition, the home may not sell at an auction. If the minimum amount the lender requires is not met, the home will then be transferred to the lender’s Real Estate Owned, or REO department along with the rest of the lender’s foreclosed inventory. Too much of this inventory and the lender may soon find they’re no longer competitive in the mortgage marketplace. Lenders make money by making loans, not by foreclosing on them.
Standard Waiting Periods With a Short Sale
There are mortgage programs for those who have experienced a short sale or foreclosure yet the potential borrowers need to clear a few hurdles. The first is to reestablish credit. This might seem difficult at first because what credit company would issue a credit card to someone with damaged credit? There are in fact credit companies that issue credit cards and make automobile loans for those very people, helping to reestablish credit. Lenders will want to see a credit of 700 be attained as well however individual lenders can adjust this score requirement if there are other compensating factors in the file such as a larger down payment than what is required. Lenders may also require at least three trade lines be established with at least two years of timely payment history. A trade line is a credit line that appears on a credit report and can also include rent payments to a landlord or apartment building.
For conventional loans, those underwritten to guidelines established by Fannie Mae and Freddie Mac, borrowers must wait at least two years with repaired credit in order to qualify for a new mortgage. For those with a foreclosure, the wait is even longer. Seven years must pass with repaired credit. Conventional mortgages are by far the most common home loan type and have some very competitive interest rates yet after a short sale or foreclosure the waiting period is long. In either event, the borrowers will be asked to provide evidence the short sale or foreclosure occurred due to events beyond the borrower’s control.
Government-backed loans such as FHA and VA also allow for a new mortgage after a short sale or foreclosure. With an FHA loan, borrowers must wait at least three years from a short sale or a foreclosure. VA loans are the least harsh requiring just two years to pass for either a short sale or a foreclosure. This two year period will lapse quickly and often times not be enough for the potential borrowers to have sufficiently repaired their credit with at least a two year history of timely payments.
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Back to Work
FHA does offer a unique loan program that allows for a one year waiting period but only under some very strict circumstances. FHA’s “Back to Work” home loan is designed to allow buyers to finance a home with an FHA loan after one year of a “derogatory event” such as a foreclosure or short sale. Under this program, borrowers can obtain an FHA loan at any FHA approved lender.
There are some requirements the potential borrowers must meet, however, and there are few exceptions. First, the borrowers must document their income fell by at least 20% for a minimum six month period. This drop in income can be established in multiple ways such as providing copies of old pay check stubs and W2 forms. The lender can also contact the previous employer and get written certification the borrowers were either laid off or had their pay reduced by at least 20%. Note, this 20% amount relates to all members of the household, not just one individual. That means if two people are on the mortgage and one loses a job then two months later gets another if the 20% drop in income doesn’t last for six months the Back to Work program won’t work. FHA guidelines are strict in this regard and are the primary reason why this program is so difficult to qualify for. While the Back to Work program has good intentions, the documentation process puts this loan out of reach for most and they end up waiting the required three year period for an FHA loan after all.
Overlays When It Comes To a Short Sale
While a conventional mortgage or a government-backed loan is an option after the waiting period and reestablished credit is validated, individual lenders may have additional requirements that go beyond standard qualifying criteria. These additional requirements are referred to as “overlays” and are items such borrowers must address to satisfy the individual lender. Overlays aren’t applied to make loans easier to qualify for but to fortify an existing application with more requirements.
For example, a borrower had a foreclosure more than seven years ago and has reestablished three trade lines. Yet the lender requires that any borrower with a past foreclosure must put at least 25% down and have a credit score of 740 or better. While Fannie may not have this requirement a lender could. As long as a lender overlay applies to all borrowers equally, the lender has every right to put forth an overlay to mitigate risk.
Another overlay that can affect the loan is higher interest rates. Higher interest rates are typically reserved for so-called “subprime” borrowers who have damaged credit but even for those who are on the road to credit recovery can find themselves with a higher interest rate compared to another borrower with no such foreclosure in the past. Overlays can mean more down payment, higher rates and pristine credit.
And finally, these programs are also restricted by loan size and depending upon the area, may not be available for those who want to obtain a jumbo loan. If buyers want to finance a loan greater than the conventional or government limits, the buyers must put more money down to get the loan balance where it has to be or find other alternatives.
Got a question for Chad? Call (858) 353-8331 or request more info
Conventional Loan Limits
The most common type of mortgage is the conforming conventional loan. These are the loans approved using Fannie Mae and Freddie Mac guidelines. Both set their own loan limits and in most parts of the country the maximum loan amount for a conforming loan is $417,000 but here in San Diego County the maximum is $580,750 for 2016. Anything above this amount is considered a jumbo loan here in San Diego County. This is important because the most competitive mortgage rates are reserved for this loan class. This $562,350 limit is for a single family home yet many buyers take advantage of this program to buy a two or four unit property. For a duplex, the loan limit is $743,450, a three-unit home has a limit of $898,700 and a fourplex is $1,116,850.
As we mentioned earlier, conventional loans require a two year waiting period after a short sale and a waiting period of seven years after a foreclosure.
FHA Loan Limits
The Federal Housing Administration also sets loan limits for loans approved using FHA standards. The loan limits for FHA loans in San Diego County are also $580,750, $743,450, $898,700 and $1,116,850 for a single family home, duplex, three-unit, and fourplex respectively. FHA guidelines allow for borrowers to finance a 2-4 unit home as long as the borrowers occupy one of the units. As well, FHA loans require a three-year waiting period for either a short sale or foreclosure unless the borrowers qualify for the FHA Back to Work program which has a one-year waiting period.
VA Loan Limits
VA loan limits are the same as FHA loans of $580,750, $743,450, $898,700 and $1,116,850. VA loans are restricted to honorably discharged veterans of the Armed Forces, active duty personnel with at least 181 days of service, those with at least six years of service in the National Guard or Armed Forces Reserves and unmarried surviving spouses of veterans who died as a result of a service-related injury. The waiting period for a VA loan is two years after a short sale and two years after a foreclosure.
USDA Loan Limits
The USDA mortgage program, designed to assist those who want to buy a primary residence in a rural or semi-rural area can take advantage of the USDA loan and not require any down payment. USDA loans are restricted based upon the location of the property as well as specific income limits. However, the USDA doesn’t establish loan limits but do restrict how much someone can borrow based upon prevailing interest rates and income limits of 115% of the median income for the area. Based upon this data, the approximate loan limit for a USDA loan is $340,000 to $417,000 based upon the number living in the household. The waiting period to use a USDA loan to buy and finance an owner occupied property is three years for either a short sale or foreclosure.
Portfolio Loan Limits
Portfolio loans are so-called because an individual lender does not intend to sell the home in the secondary markets like conventional and government-backed loans can. Instead, the loan is kept “in house” or in their portfolio. That means lenders can set their own lending standards regarding credit, income and loan limits. Portfolio loans are usually shorter term in nature such as two or three years, depending upon the lender’s requirements
Non-conforming simply means loans that do not conform to typical conventional guidelines and have their own standards, much like portfolio loans have. However, there are secondary markets where lenders buy and sell non-conforming loans either individually or in bulk. These loan types also set their own guidelines with regard to short sales and foreclosures and do not necessarily adhere to a conforming loan limit but do have a maximum loan limit.
For example, we have a loan product that has a maximum loan amount to $1.1 million with a 15% down payment. This program isn’t restricted to a jumbo loan but does have the $1.1 million maximum. The important thing to note here is that there is another market outside the conventional government suite of mortgage products yet not all lenders offer them much less know about them. Some lenders simply concentrate their efforts on the most common loan types such as Fannie or Freddie type loans. But for those who want to buy a home after a short sale or foreclosure can in fact run into situations where a conventional loan or government-backed mortgage simply does not work while a non-conforming loan may very well be the answer.
Unique Jumbo Programs Post Short-Sale and Foreclosure
If the buyer has waited four years after a short sale and has reestablished credit there are options other than for those needing financing but don’t want to put down 30% or more. We have a product that will finance a jumbo purchase up to 85% of the value of the property up to 1.1 million.
For those who have experienced a short sale or a foreclosure and have 25% available for a down payment we have a unique mortgage offering with:
- Two years waiting period instead of four
- 25% down payment
- Extremely competitive interest rates
- FICO minimum 700, better rates for >740
- Maximum loan amount 1.5 million
We can also provide financing for someone just one day out of a foreclosure or short sale with:
- One day out of foreclosure or short sale
- 20% down to 1.5 million
- Rates slightly higher compared to the 25% down jumbo loan program
- Only one housing incident allowed
With 20% down we can offer financing just two years out of a short sale or foreclosure with loan amounts to $5 million as well with very competitive interest rates.
If you or someone you know has experienced a recent short sale or a foreclosure and doesn’t want to be locked out of the home buying process, there are programs available that just might work and they’re very competitive with rates and fees as well.
Short sales or foreclosures are an unfortunate event, but they’re not a lifelong problem.
Everything about our transaction with this lender was perfectly explained to us, easy to do, and they were able to help us get our loan closed ahead of schedule. It was a perfect 10 and we couldn’t have been happier with the whole thing
“Thank you for all the hard work (even on weekends!) you and your team have devoted to seeing this through in a very efficient manner. It’s been an easy process for me and, you and your team have been a delight to work with.”
“Hey Chad – thank you so much to you in particular as well as your team. It’s been a real pleasure working with someone who’s as responsive and helpful throughout the process, as you’ve been. We really appreciate what you’ve done. ”