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Damage to Credit
Avoiding Foreclosure Does Not Mean Avoiding Damage To Credit

Even though agreed upon arrangements like short sales and deeds-in-lieu to sell a house or return it to the lender avoid a foreclosure being filed, they can still damage your credit.  The penalties that lenders apply before they will lend to you again vary depending on the type of mortgage you seek – FHA, conventional, VA or USDA and other factors.

Conventional loans are the most popular form of financing, but tend to have stricter standards for credit.  “Conventional financing” describes loans underwritten to Fannie Mae and Freddie Mac standards.  Fannie and Freddie do not loan money to borrowers, rather they purchase the mortgage from the lender after it is finalized if the mortgage meets certain stringent criteria.  Because lenders want to sell their loans to Fannie Mae and Freddie Mac, they generally will not give conventional loans to borrowers who do not meet Fannie and Freddie standards.

The fact that a homeowner agreed to a short sale or a deed-in-lieu may not be readily apparent on the homeowner's credit profile if it is reported to the credit bureau as “paid satisfactorily” or something similar.  However, if it is reported as “settled for less than the full amount due,” then it will have the same impact on your credit as a foreclosure.  Furthermore, Freddie Mac classifies all short sales as significant derogatory credit events, no matter how it is reflected on your credit report.  

When a borrower has a significant derogatory credit event, most lenders will do a comprehensive review of the borrower's current finances and credit re-establishment via manual underwriting, allowing the lender to scrutinize credit much more closely than with automated underwriting.


 
  • The Waiting Period

    After a significant derogatory credit event, Freddie Mac and Fannie Mae have certain acceptable time frames that must pass before they consider your credit reestablished to the point where you are once again eligible for a mortgage.  The time frame is shorter if your financial mishap was caused by extenuating circumstances rather than financial mismanagement.

    Generally, extenuating circumstances are isolated events that are beyond your control and dramatically affect your ability to continue making payments on your mortgage.  Extenuating circumstances include divorce, job loss or relocation and serious illness, injury or death of a wage earner.
     
    For example, if a short sale was due to extenuating circumstances, then Freddie Mac’s time period for your credit to be reestablished is 24 months from the sale’s completion date; if the short sale was due to financial mismanagement, the recovery period is 48 months from the completion date.  

    Another factor is whether the borrower was delinquent on the note prior to the short sale or deed-in-lieu.  If delinquent, a short sale or deed-in-lieu is often treated the same as a foreclosure in regard to qualifying for another mortgage later on.  

    FHA is the most forgiving program for those with a foreclosure, deed-in-lieu or short sale with delinquency and that is a three year wait for another mortgage.  But if you do a short sale or deed-in-lieu and keep the payments current, then Fannie Mae and Freddie Mac require only a twelve month waiting period, whereas most lenders for the VA require the passing of at least two years



  • The Down Payment

    For a shorter waiting period, some loans require a significant down payment and a minimum FICO score.  As of 2010, Fannie Mae standards allow borrowers to gain loan approval in as few as two years after a deed-in-lieu, but the time period varies depending on the down payment and the presence of extenuating circumstances.
     
    Borrowers with a 20% down payment and re-established credit can qualify after two years; borrowers with 10% down must wait at least four years.  Borrowers with down payments between 5 percent, but less than 10 percent must wait up to seven years, depending on the specific loan program's eligibility requirements.


  • Bankruptcy

    The waiting period after a bankruptcy also depends on the type of mortgage being applied for as well as the type of bankruptcy.  Freddie Mac’s recovery time period requirement for reestablishment of credit after a Chapter 13 bankruptcy caused by financial mismanagement is 48 months from the dismissal date or 24 months from the discharge date.

    FHA and VA will give you a new mortgage one year into a Chapter 13 repayment plan if all payments have been made as agreed and there are no other derogatory credit events.  USDA’s criteria is one year after the Chapter 13 discharge date.

    If the filing is a Chapter 7 bankruptcy and you are applying for a conventional loan, then you must wait 48 months after discharge or 24 months if you can prove extenuating circumstances.  FHA and VA will only make you wait 24 months or as short as 12 months with acceptable extenuating circumstances.  USDA requires you to wait 36 months after discharge.