Buying a Home After Foreclosure
There are certain instances in which buying a home may become more complicated, and buying a home after you have had a foreclosure on your credit report is one of them.
Although a lot of lenders see a foreclosures as a significantly negative credit event, there are ways to minimize the effect it has on credit, as well as your ability to buy a home in the future.
1. Common Waiting Periods
It depends on the lending institution, but most lenders set some limits on the length of time that buyers must wait after a foreclosure in order to apply for mortgage financing. The standard waiting period for most conventional loans is seven years, calculated from the time that the foreclosure was completed. That date may fall months or even a year after the mortgage went into default.
The Federal Housing Administration (FHA) requires a three-year waiting period. The “Back to Work” Program, an FHA program that reduced waiting periods for home buyers who had a foreclosure, was discontinued in September 2016. Loans conforming to Fannie Mae’s or Freddie Mac’s standards typically call for waiting seven years. However, applicants who can prove that their foreclosure was related to extenuating circumstances that are not likely to recur may only need to wait three years after their foreclosures are finalized.
2. Improving Credit
Beyond the actual foreclosure showing up on the credit report, the rest of the credit report is often one of the biggest hurdles that prospective buyers have to cross to get another mortgage loan. Foreclosures are considered a “significant derogatory credit event,” along with various kinds of bankruptcy and in some cases, short sales. Experts suggest that a foreclosure may drop a credit score as much as 100 points or more.
This underscores the importance of building up your credit as much as you can in other ways. If you are very careful about making all other payments on time, and keeping your debt-to-available-credit ratio low, your credit score may rebound more quickly. Although the foreclosure may stay on the report for seven years, the hit to the credit score tends to lessen after the first couple of years.
3. Balancing Debt and Income
A big part of persuading a lender to take on applicants with prior foreclosures is convincing them that the borrower is a safe bet for the future. Anyone who has a foreclosure on their record is a prior homeowner, which means that they have already been approved for a mortgage loan once before, have gone through the process of buying a home, and have some idea of what is expected of them.
These factors are typically all positive aspects to lenders, and the foreclosure may be the only part that raises questions. Demonstrating that the foreclosure has led to improvements in financial dealings will go a long way to assuring the lender you are a less risky candidate. If you can show that your income is stable and you have worked to keep your debt under control, you may be able to demonstrate that you have moved on and deserve a second chance.
4. Limits on Government Loans
There are certain instances in which buyers with a foreclosure in their past may not be able to qualify for certain government loans, but these type of loans are highly specific. The federal government maintains records of mortgage delinquencies for loans that were guaranteed with government money, such as FHA loans or Department of Veterans Affairs (VA) loans.
When these loans go into foreclosure, the owner of the debt typically makes a claim and the government pays for it. Government employees then record the payment in the Credit Alert Verification Reporting System (CAIVRS). People who have had FHA loans or VA loans become delinquent or go into foreclosure are typically not allowed to apply for another government-insured loan until the claim has been repaid.
5. Down Payments and Reserves
Foreclosures are often considered to be something that people only do rarely or caused by an extreme situation, when their savings and income could not support a loan. As a result, most lenders want evidence that a home buyer will be able to provide money for future mortgage payments in the event that they lose a job or face unexpected necessary expenses.
This usually comes in the form of a down payment and reserves. People who complete the required waiting period may be able to qualify for FHA loans with down payments as low as 3.5 percent. However, Fannie Mae only allows people to qualify for a loan three years after a foreclosure if they make a minimum down payment of 10 percent. Lenders may also ask for a higher amount of monthly expenses in reserve, such as 12 months instead of six months.
6. Shopping Around
Buying a home after credit trouble requires some shopping around. Some lenders may not be willing to take on an applicant without great credit and a large down payment. However, the Great Recession demonstrated that even people who generally make wise financial decisions can still get caught in a bad economy, and face foreclosure as a result.
Plenty of lenders understand this fact and may be willing to take a chance on a buyer with a foreclosure on their record, but with a lot of promise as well. Be prepared to submit an application with more than one lender, and do not get discouraged if the first one doesn't work out.. You may find luck with a mortgage broker, who can help you sort through potential lenders to find those that are more likely to approve your application. Over time, with some practical decisions, you will likely be able to get a good mortgage offer from a reliable lender.
7. Working with a Real Estate Agent
The home buying process is all about full disclosure. It can be tempting to avoid telling or working with a real estate agent because of a foreclosure, especially if the waiting period is complete. However, the agent will have an easier time tailoring the home search appropriately if all financial concerns are properly enumerated. Your real estate agent will likely recommend getting mortgage pre-approval before looking for homes, so that sellers know you can make good on the offer.
Going through a foreclosure is a stressful experience, but it does not need to affect your life forever. After an appropriate waiting period, you may improve your credit, save money and prepare to buy another home, once you are ready.