I asked Doug Katz,
a sales manager at Chicago Bancorp, to write a follow up article on the differing impacts of the various ways of walking away from your home
and mortgage. The first article dealt with the impact of mortgage default on your credit score.
In our present economy, the terms foreclosure, short sale, and deed-in-lieu of foreclosure have become more commonplace. More and more homeowners strapped with homes that they simply cannot afford are making the tough decision to default on their mortgage obligation. Although such a decision solves an immediate problem, the echo of a mortgage default or foreclosure can go well beyond a simple hit to your credit score. Beyond the obvious drop in FICO score and nasty line item on your credit report, the actual impact of these events in the eyes of future creditors needs to be understood.
Will Fannie Mae ever forgive me?
For those not familiar with
the mortgage industry, Fannie Mae and her little brother Freddie Mac are
the big dogs in mortgage lending. They buy the vast number of loans
originated in the United States and, because of this, they set many of
the rules regarding acceptable credit risk. Criteria such as acceptable
income, required cash reserves and credit score are just a few
examples. Also included in their loan approval guidelines is the credit
history of the borrower, which is comprised of items like on-time
payment history, delinquencies, judgments and, you guessed it,
derogatory mortgage events such as a foreclosure, short sale or
deed-in-lieu of foreclosure.
Since Fannie Mae got left holding
the bag on a huge number of mortgage defaults, they have become very
sensitive to a potential borrower’s mortgage history. In response to
mounting loses, they have adjusted their loan approval criteria to match
the new risk. In a sense, they have internalized the fool me once
shame on you, fool me twice shame on me philosophy. The good news,
however, is that unlike credit scoring, where all events were equally
weighted, Fannie Mae looks at each event with a different level of
severity and penalizes potential borrowers accordingly.
general, you can expect to wait 7 years to qualify for a new Fannie Mae
loan after a foreclosure. This lending limbo can be tempered with
extenuating circumstances and verifiable hardship from such things as
medical bills at which point you can expect to wait 3 years. Because
short sales and deeds-in-lieu of foreclosure do not result in a very
costly foreclosure process, they are treated with less severity. In
these cases, you can expect to wait 2 years before consideration for a
new Fannie Mae loan. Any loan approved after the first two years would
only be considered at a reduced loan amount, which increases over time
and eventually reaches 100% in the 7th year. Once again, verifiable
extenuating circumstances will reduce the waiting period a bit.
How about FHA?
is another entity that is influential to the lending industry and that
is the Federal Housing Administration (FHA). This organization insures
loans on behalf of the government in support of home ownership and,
therefore, sets the criteria under which they will operate. Guidelines
and requirements for FHA loans tend to be a bit more liberal than Fannie
Mae loans, which helps those recovering from a foreclosure, short sale
or deed-in-lieu of foreclosure. The waiting period for borrowers
seeking an FHA loan after derogatory mortgage event is 3 years
regardless of what type of event they experienced. Extenuating
circumstances can reduce or eliminate the waiting period, but they must
be verifiable and documented.
In the end, the decision to pursue a
short sale or to default on a mortgage loan is a difficult one. More
often than not, it is the end of a difficult road made up of financial
hardship and emotional torment. Aside from the financial impact,
homeowners forced into a less than desirable outcome can be plagued by
feelings of shame and failure. Rarely is the long-term impact a
consideration. By understanding the ground rules and how creditors will
evaluate you in the future, however, you can establish a plan for
recovery and future home ownership.
Sales Manager – Private Label Banking
other caveat. You should seek the advice of an attorney before deciding
which alternative to pursue because there are other considerations
besides the impact on your credit score.