In this series of articles (“Bank Turndowns”), we explore why borrowers are turned down by their bank for a loan, and how they can get approved by another lender. To access all the volumes in this series, go to our “Series” page here.
Perhaps you are interested in purchasing a new home, but you recently went through a bankruptcy, foreclosure, deed-in-lieu of foreclosure, or short sale. You may think that, due to the recent damage to your credit history, it is not possible to qualify for a home mortgage loan.
However, that is a common misconception.
These events do not permanently ruin your credit, and there are lenders out there who understand that you need to rebuild your credit score and are willing to approve you for a loan.
You may be able to rebound from your negative credit event (whether it was a bankruptcy, foreclosure, deed-in-lieu of foreclosure, short sale, etc.) much sooner than anticipated and still go on to become a homeowner.
The key factor that lenders consider in whether to offer a loan is how much time has passed since the event in question. This passage of time is also known as “seasoning” or the “waiting period”.
We outline below the different waiting periods (which range greatly from several years to as little as just one day) and any additional requirements.
Waiting Periods for Conventional Loans (Fannie Mae/Freddie Mac)
Overview: Under Fannie Mae and Freddie Mac guidelines for single-family homes, the waiting periods range from two years to seven years, depending on which “significant derogatory credit event” is at issue, and whether you can demonstrate any “extenuating circumstances.” Regardless of the waiting period, you must also demonstrate that you have “re-established” your credit.
According to Fannie Mae and Freddie Mac, examples of “significant derogatory credit events” include:
- Bankruptcy (Chapter 7, 11 or 13);
- Multiple bankruptcy filings within the past seven years;
- Deed-in-lieu of foreclosure (i.e., a transaction in which the deed to the real property is transferred back to the servicer of the loan);
- Short sale (a.k.a. preforeclosure sale) (i.e., the sale of a property in lieu of a foreclosure resulting in a payoff of less than the total amount owed, which was pre-approved by the servicer of the loan); and
- Charge-off of mortgage account (i.e., when the creditor has determined that there is little or no likelihood that the mortgage debt will be collected).
In their guidelines, Fannie Mae and Freddie Mac state that the presence of a “significant derogatory credit event” increases the likelihood of a future default and represents a significantly higher level of default risk. As such, Fannie Mae and Freddie Mac will not buy or guarantee these loans unless a certain waiting period has elapsed since the significant derogatory credit event took place.
Below is a table summarizing Fannie Mae and Freddie Mac’s waiting period requirements for each type of significant derogatory credit event:
As you can see, the waiting periods are shorter if you can show “extenuating circumstances,” which Fannie Mae and Freddie Mac define as “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.” Examples of extenuating circumstances include divorce, illness, sudden loss of household income, and job loss.
In addition to the waiting periods outlined above, you must also demonstrate that you have “re-established” your credit, which means that:
- You must meet the minimum credit score requirements based on the parameters of the loan; and
- You must have enough of a traditional credit history containing a sufficient snapshot of your accounts and payments for the lender to analyze. Nontraditional credit or “thin files” are not acceptable.
Waiting Periods for Federal Housing Administration (FHA) Loans
Overview: Under the Housing and Urban Development (HUD) guidelines for single-family homes, the waiting periods range from one year to three years depending on which credit event is at issue, and whether you can demonstrate any “extenuating circumstances.”
Compared to Fannie Mae and Freddie Mac, the FHA has slightly shorter waiting periods and different additional requirements depending on the type of derogatory event. Like Fannie Mae and Freddie Mac, the FHA also allows for “extenuating circumstances” to shorten the waiting periods.
The extenuating circumstances must be beyond your control, such as a serious illness or death of a wage earner. For foreclosures, deeds-in-lieu, and short sales, while divorce is typically not considered an extenuating circumstance, an exception may be granted if your mortgage was current at the time of your divorce, your ex-spouse received the property, and the mortgage was later foreclosed or there was a subsequent short sale. The inability to sell the property due to a job transfer or relocation to another area does not qualify as an extenuating circumstance.
Below is a table summarizing the FHA waiting period requirements, and any applicable additional requirements, for each type of event:
HELPFUL TIP: As an important exception for short sales, the FHA requires no waiting period at all if you are current at the time of the short sale. Specifically, you have to show (1) all mortgage payments on the prior mortgage were made within the month due for the 12-month period preceding the short sale; and (2) installment debt payments for the same time period were also made within the month due.
Waiting Periods for Veterans Administration (VA) Loans
Overview: Under the VA guidelines, the waiting periods range from one year to two years depending on which credit event is at issue, and whether you can demonstrate any special “circumstances”.
Below is a table summarizing the waiting period requirements, and any applicable additional requirements, for each type of event recognized by the VA:
To qualify for the shorter waiting periods for Chapter 7 bankruptcies, foreclosures, or deeds-in-lieu, you would have to demonstrate that the event was caused by extenuating circumstances beyond your control such as unemployment, prolonged strikes, or medical bills not covered by insurance. Divorce is not generally viewed as beyond your control.
HELPFUL TIP: In a foreclosure situation, if the foreclosed loan was a VA loan, you may not have full entitlement available for the new loan. In other words, entitlement might not be restored if your original VA loan was not repaid in full. Work with the lender to check your Certificate of Entitlement and see how much you are permitted to borrow without putting any money down.
Waiting Periods for Non-Conventional Loans
Overview: If you cannot wait the required time periods under Fannie Mae, Freddie Mac, FHA or VA guidelines (which can be as long as seven years), you may want to consider obtaining a non-conventional loan from an alternative lender that has waiting periods as short as one day since the event in question. However, expect to pay higher interest rates.
Alternative lenders offer special programs for borrowers who have very recently undergone certain negative credit events. For instance, some alternative lenders require only a one-year waiting period for bankruptcies, without requiring you to show any extenuating circumstances.
Other alternative lenders may qualify you even if you are just one day out of foreclosure, short sale, bankruptcy, or deed-in-lieu of foreclosure.
After a bankruptcy, foreclosure, deed-in-lieu of foreclosure, short sale, or charge-off of mortgage account, you might think homeownership is not an option, or that the only home loans you will be able to obtain will come with high interest rates. However, if you can get past the Fannie Mae, Freddie Mac, FHA or VA waiting periods and rebuild your credit score, you may have access to the same interest rates and terms as anyone else.
Alternatively, if you cannot wait that long, there are lenders out there who are willing to extend credit in as little as one day after the event in question.
Whatever the negative event in your credit history, a mortgage broker can help you parse through the different waiting period requirements and other additional requirements to get you on the path to loan approval, and, ultimately, home ownership.
Continue exploring our “Bank Turndowns” series:
To access all the volumes in this series, go to our “Series” page here.
David A. Krebs is a licensed mortgage broker offering commercial and residential loan programs beyond your regular bank. Call us at 321-239-2781, click here to submit a message, or click here to book a free consultation.