Article updated on August 15, 2018
Boomerang mortgage borrowers are back. Some of the millions of people who lost their homes to a foreclosure, bankruptcy or short sale during the past decade are returning to the real estate marketplace. What makes their homecoming possible? The time required to wait for new financing has tumbled from as long as seven years to as little as 12 months and in a few cases even less.
Sean Fergus with John Burns Real Estate Consulting says there were 5.3 million households who lost their home to a foreclosure or short sale from 2007 to 2013. Of this number, he states that 889,000 have already bought homes while another 2.8 million will return to the marketplace by 2021.
Existing home sales are now running at 5 million per year, more or less. If Fergus is right and 2.8 million boomerang buyers will re-enter the real estate marketplace during the next seven years, that means roughly 400,000 sales per year – about 8 percent of all existing purchases – will come from buyers who once faced a foreclosure, bankruptcy or short sale. Without these purchasers, the real estate market will be weaker, with less pressure to push up prices.
Buyers with these types of significant derogatory events in their credit history usually need to be pre-approved by a lender before sellers will accept their offer on a house.
Although foreclosures, bankruptcies or short sales will remain on a borrower’s credit report for several years, mortgage lenders are increasingly making loans to buyers with major credit dings. You can see this with the three major financial options used by most homebuyers: FHA, conventional, and VA mortgages.
To qualify for an FHA loan, borrowers must meet these criteria:
- To qualify for an FHA loan after a Chapter 7 bankruptcy: The waiting period is two years from the time the bankruptcy is discharged plus any additional amounts required by a lender. The borrower must also establish a history of good credit following the Chapter 7 filing and meet additional FHA requirements.
- To qualify for an FHA loan after a Chapter 13 bankruptcy: Borrowers can still be paying on a Chapter 13 bankruptcy and be considered for an FHA loan, but only if the payments have been made and verified for a period of at least one year (12 payments). This is not automatic; the court trustee's written approval is a condition of the policy. Additionally, the borrower must provide a detailed explanation of the bankruptcy and submit it with the loan application. Good credit, a satisfactory employment history and other financial qualifications are also required.
- To qualify for an FHA loan after a foreclosure: Borrowers must wait 3 years after the foreclosure date and also have established a history of good credit.
After the financial meltdown, conventional mortgages were mostly off-limits for borrowers who had encountered what were called “significant derogatory events.” The good news is that the requirements have changed and many borrowers who suffered through tough times will now be able to get a conventional loan.
In basic terms, a conventional loan can be seen as financing with 20 percent down that meets the standards established by government-sponsored enterprises Fannie Mae and Freddie Mac. The requirements laid out by the two mortgage giants are generally close, if not identical, but where they are different you only need to meet whichever standards are more liberal and best answer your needs.
Also, to get a conventional loan you don't need 20 percent down if you get private mortgage insurance. With such insurance, you can typically buy with as little as 5 percent down, plus closing costs.
The past standards for conventional mortgages after an “economic event” were brutal – in many cases you had to wait seven years after a foreclosure to qualify for a new loan. But the game has changed.
To figure out how quickly you can qualify for a mortgage after one of those “significant derogatory events,” you have to look at what happened, when it happened, and why. In particular, you have to see if there were any extenuating circumstances to justify the swift reinstatement of your ability to get a mortgage. According to Fannie Mae, “extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.”
Translation: Think of such things as a job loss, big medical bills or a car accident.
So what are the new standards? Let’s look at some specifics and compare the old rules and the new ones:
Short sale, deed-in-lieu of foreclosure, or charge-off:
Fannie Mae divides mortgage applicants into two groups, those with extenuating circumstances and those without. Those without fall into what’s called the “standard” category. In the past, borrowers had to wait as long as seven years before they could qualify for a new mortgage after a short sale or deed-in-lieu of foreclosure. Now borrowers must generally wait four years instead of seven and borrowers with extenuating circumstances can now get a new loan in just 24 months.
Waiting periods for bankruptcies vary, depending on the type of bankruptcy involved. Now the general rule is just two years with extenuating circumstances. However, if there has been more than one bankruptcy during the past seven years, then with extenuating circumstances the wait is three years.
The usual wait for new financing after a foreclosure is seven years. With extenuating circumstances, however, borrowers can get new loans in as little as three years.
VA financing – loans with nothing down and no annual mortgage insurance – is available to those who have qualifying federal service, usually with the military.
Wait periods for VA loans after a short sale, bankruptcy or foreclosure vary. In fact, there may be only a short waiting period because the decision to offer a mortgage after a negative financial experience is up to the lender.
For instance, the U.S. Department of Veterans Affairs says “the fact that a home loan foreclosure (or deed-in-lieu of foreclosure) exists in an applicant’s (or spouse’s) credit history does not in itself disqualify the loan.” (emphasis theirs)
The VA also has a few words to say about bankruptcies. It tells lenders, “you may disregard a bankruptcy discharged more than two years ago.”
As for bankruptcies discharged within the last one or two years, the VA says “it is probably not possible to determine that the applicant or spouse is a satisfactory credit risk unless both of the following requirements are met:
“the applicant or spouse has obtained consumer items on credit subsequent to the bankruptcy and has satisfactorily made the payments over a continued period, and
“the bankruptcy was caused by circumstances beyond the control of the applicant or spouse, such as unemployment, prolonged strikes, medical bills not covered by insurance, and so on, and the circumstances are verified. Divorce is not generally viewed as beyond the control of the borrower and/or spouse.”
In effect, the VA has a facts and circumstances test, which allows lenders to use their own judgment when a borrower seeks a VA loan after tough times. In such situations, the lender will look at the individual’s loan application and try to figure out whether the borrower has returned to good economic health.
The guidelines and standards for FHA, VA and conventional loan waiting periods presented here may change, and in all cases, lenders have to consider each individual mortgage application before making a loan commitment. However, the general trend is clear: The harsh standards that emerged after the mortgage meltdown are gradually giving way to more flexible policies. The result is that more buyers can come back to the real estate marketplace.
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