One of the biggest credit obstacles when it comes to applying for a mortgage is getting a mortgage after a foreclosure. After all, foreclosure involves a default on a mortgage, and you will be looking to apply for a new one. How will a mortgage lender view that? Actually, by taking a few strategic steps, and letting some time pass, you can have a second chance at homeownership, even if you have a foreclosure in your past.
General Rules for a Mortgage After a Foreclosure
The general rules on foreclosure are determined by the type of mortgage that you are applying for.
For example, if you are applying for a conventional mortgage loan (issued by Fannie Mae or Freddie Mac), you generally have to wait at least seven years after the foreclosure in order to apply for a new mortgage. And for what it’s worth, the seven-year waiting period is measured from the completion of the foreclosure, and not the initiation. The actual date will depend upon what is reported by the credit report.
If you are applying for an FHA loan, the waiting period is typically three years. Meanwhile, VA mortgages require that you be at least two years out of foreclosure before applying for a new loan.
The Reason Behind the Foreclosure Matters
General guidelines do provide for some flexibility, but only under certain circumstances. The reason for the foreclosure is critical in such cases. If the foreclosure was the result of strategic default, or of simply an inability to make your payments, then the general guideline time frames will apply. However, if the foreclosure was caused by extenuating circumstances, the waiting time may be reduced.
For example, if the reason for the foreclosure was a factor beyond your control, you may qualify for the reduced term. Extenuating circumstances would include events such as divorce, job loss, or a serious illness or death in the family. Each of these events could have triggered the factors that led to the foreclosure.
If any of them did, then you can get a conventional mortgage loan in as little as three years, and FHA and VA mortgages in as little as one year.
In the case of conventional mortgage loans, you will be required to prove in writing that the foreclosure was the result of extenuating circumstances. That may require that you provide documentation of a serious illness, a death in the family, a job loss or a business failure.
Conventional lenders will also most likely limit the size of your mortgage to no more than 90% of the purchase price or value of the property. You will also be required to use the new mortgage either for the purchase of a primary residence or for a limited cash out refinance on an owner occupied property. However, you will not be able to use the mortgage to purchase either a second home or investment property.
Your Credit Must be Squeaky Clean Since the Foreclosure
One of the concerns with foreclosures is that they stay on your credit report for a very long time. In fact, a foreclosure stays on your credit report for seven years. It’s almost certain that you will need to purchase a new home within those seven years.
Your credit history since the foreclosure will be an important consideration for the mortgage lender. If you have another major derogatory on your credit report, that happened since the foreclosure, such as a bankruptcy, a court judgment or a tax lien, your credit may be determined to be unacceptable. And while it may be okay to have an occasional late payment, a consistent pattern of late payments will also likely result in a loan decline.
It’s important that you keep your credit as clean as possible after the foreclosure. This will be particularly true in the last two or three years leading up to your new mortgage application.
The purpose of showing good credit is not just to signal that you are a good credit risk or have a good credit score. It is more about demonstrating that the problems that lead you into foreclosure are behind you, and you are now in full control of your financial situation.
Develop Off-setting Strengths
Anytime you are applying for a mortgage and you have a significant weakness in your financial profile, it will be very important to develop clear offsetting strengths. Those strengths will counterbalance the negatives, and often lead to a loan approval.
Examples of offsetting strengths, or what are known in the mortgage industry as compensating factors, includes:
- Making more than a minimum down payment on the property
- Having significant savings left over after the closing
- Having very little non-housing debt
- Having low debt-to-income (DTI) ratio that makes it very likely that you will be able to make your housing payment easily
If you have experienced a foreclosure, you should work to develop at least one or two of these compensating factors. They can give the mortgage company a justifiable reason to approve your loan, despite the foreclosure.
If You Have a Foreclosure in Your Past, Sit Down With a Loan Officer
If you have a foreclosure in your credit history or at least one that took place within the past seven years, it’s important to do some advance planning. The best way to do this is to sit down with a mortgage loan officer and craft a strategy.
As an industry professional, your loan officer will know the right questions to ask, and the right documentation that will be needed in order to make your loan approval possible.
Be very proactive in this step. You should meet with a loan officer a couple of months before you even begin shopping for a property. That will give you time to do what is necessary to get your financial situation prepared for the loan application ahead.