Starting over after foreclosure

Posted: February 24, 2012

Next to filing for bankruptcy, nothing wrecks your chances of qualifying for a home loan like a foreclosure.

And if you got out from under an oppressive mortgage through a short sale, in which the bank agreed to accept less than you owed, future lenders may look upon you just as unfavorably.

This is the reality former owners of the more than four million homes lost to foreclosure in the six years since the housing bubble burst will have to confront. That's because the mortgage-lending guidelines most banks follow prohibit them from making loans to people with foreclosure or a short sale in their credit history, often for years. Never mind the hit a credit score takes.

The passage of time eventually helps smooth the way. Some homeowners who were foreclosed on when the market first started to skid are now looking to buy again and are getting loans.

"They're probably going to pay a little higher interest rate, but with rates so low, a higher interest rate of 4 percent is not a big deal," said Rosa Herwick, a broker and owner of Century 21 JR Realty in Henderson, Nev.

How likely is a bank to approve your mortgage application if you have a real estate-related blemish on your record? And can you do anything to spring yourself from the mortgage penalty box?

It depends on several factors, but largely on whether you had a foreclosure or a short sale.

Foreclosure. Generally, borrowers with one in their credit history can expect to wait two to seven years before a lender will even accept their loan application.

The waiting periods stem from guidelines most banks must follow to be able to sell their home loans. That's because potential purchasers such as Fannie Mae and Freddie Mac each have a different set of criteria for the loans they will buy and whom they deem qualified borrowers.

A person's credit score, employment history, and other factors contributing to creditworthiness will take a backseat to these guidelines.

Even for government-backed mortgages, the waiting period can vary.

The Federal Housing Administration, which insures roughly 30 percent of new loans, requires former homeowners to wait three years from the date of their foreclosure before they can qualify for FHA backing.

The U.S. Department of Agriculture's housing program requires a three-year wait, while the time penalty for a Veterans Administration loan is two years. Fannie Mae and Freddie Mac, which own or guarantee about half of all mortgages, require the longest stretch: seven years after a foreclosure.

In some cases, waiting periods can be reduced. Fannie Mae, for example, allows a three-year wait in the event the foreclosure was due to an extenuating circumstance, defined as something beyond the homeowners' control that resulted in a sudden reduction in income or catastrophic increase in financial obligations. Think layoff, medical bills, or divorce.

The FHA may grant an exception in the event a wage earner becomes seriously ill or dies. A divorce may qualify for an exception, but only in certain cases.

Short sale. Roadblocks for having one of these in your credit history can be less difficult to navigate, and in some cases waived altogether.

The FHA requires borrowers who weren't paying the mortgage when they sold their house to wait three years before they can qualify for another home loan. That time penalty may be waived in certain cases, including long-term job loss. There is no time penalty for homeowners who made their mortgage payments in the 12 months before their short sale.

Down-payment size can also cut the waiting period. A down payment of 20 percent or more will trim Fannie Mae's time penalty on a borrower with a short sale down to two years from seven. Buyers who put down 10 percent can qualify after four years.

Credit score. Like most credit blemishes, foreclosures and short sales remain in a credit history for seven years.

As a general rule, the higher your score, the more it will drop as a result of a bad debt, said Barry Paperno, consumer-affairs manager for, the consumer website for Fair Isaac Corp.

FICO credit scores range from 300 to 850. In simulations, a foreclosure sent a FICO score of about 720 down to as low as 570 and took about seven years to recover fully, everything else being equal. Still, there are steps one can take to burnish one's tarnished credit rating:

While in the foreclosure penalty box, make sure to pay all your bills on time.

Get more credit. That may sound counterintuitive after a foreclosure, but beefing up your track record of good credit accounts can help boost your credit score. A car loan or a credit card will do. But if you get a credit card, pay it off every month.

Dispute any mistakes on your credit report, which can lower your score.

Don't close your oldest credit accounts. Your score gets a boost from older credit lines.

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