Rules Loosen to Buy a Home After Foreclosure, But Lenders May Balk

New rules let you get back into homeownership sooner after foreclosure — in theory. Will lenders play along?

FHA and Fannie Mae are making it easier for homeowners who lose a home to foreclosure or short sale to buy again, but it might not make much difference if lenders don’t go along with the changes — since they don’t have to.

First, here’s what’s new at FHA and Fannie:

FHA rules now let you apply for an FHA mortgage 12 months after a foreclosure, short sale, or a deed-in-lieu of foreclosure if you meet two conditions:

1.  Your loss was caused by economic conditions beyond your control.

2.  You complete housing counseling.

Note: Mortgage lenders have traditionally made you wait two years after a short sale or deed-in-lieu and seven years after a foreclosure to apply for a mortgage.

Once you’ve met the conditions, you’ll still have to meet all the usual mortgage loan rules and guidelines that lenders use for everyone — like having enough income (and not too much debt) to afford the refinanced mortgage.

Fannie Mae credit reporting fix: Fannie, meanwhile, has cleared up a credit reporting issue that was holding back former homeowners who sold their homes for less than what they owed on the mortgage (a short sale) or signed over their deed to the lender to avoid foreclosure (a deed-in-lieu).

In theory, homeowners who work with the lender on a short sale or deed-in-lieu are supposed to take less of a hit to their credit than homeowners who lose a home to foreclosure. In reality, credit bureaus haven’t distinguished short sales and foreclosures on consumers’ credit reports.

Fannie Mae resolved the credit reporting issue by telling lenders to add a special code in the case files of consumers whose short sales or deeds-in-lieu are recorded in credit histories as foreclosures. Starting Nov. 16, 2013, the Fannie Mae loan underwriting system will automatically ignore the foreclosure and correctly recognize the transaction was a short sale when the code appears. Until then, your lender will have to manually underwrite your loan to take advantage of the change.

Lenders Don’t Always Follow the Rules

This is all good news. But it remains to be seen whether these new rules will make a big difference for you if you’ve had a foreclosure, short sale, or deed-in-lieu.

Fannie Mae and FHA can change their own rules, but lenders don’t have to go along with the changes because the mortgage giants’ rules are simply minimum standards. Our sources say it’s likely that lenders will add their own, more restrictive rules.

Donald Frommeyer, president of the National Association of Mortgage Brokers, says lenders will protect themselves from future losses by adding more hurdles — called overlays — that borrowers must clear. 

“Most of the overlays have to do with adding basis points to the loan fee and to the price,” Frommeyer explains. They can also:

  • Increase the required downpayment.
  • Decide you have to wait two years instead of one.
  • Ask you to prove you’ve corrected your financial problems.

“They’ll probably ask for a written letter from the consumer to explain the previous problems and what they’re doing to solve the previous problems,” he says.

Lending Tree Spokesperson Megan Grueling agrees that lenders will add overlays to avoid risk, but predicts those rule changes will be less restrictive than they might have been in the past.

Credit Score Could Hold You Back

Regardless of the changes, if you were hurt by the recession you still may not qualify for a new mortgage because your financial troubles, especially a foreclosure, likely lowered your credit score.

How low is too low? In July 2013, the average FICO score for all closed first mortgages was 737, while the average credit score on denied loans was 702, according to Ellie Mae, which sells electronic mortgage origination systems. Credit scores go up to 850.

If you’re ready to become a homeowner again:

1.  Check your credit reports for free.

2.  Pay about $20 to get your FICO score. Credit scores aren’t included in your government-mandated free credit report, and the score you pay for may not even be the exact credit score lenders see. But it can help you decide if your credit will hold you back from getting a mortgage.

3.  If your score is too low for you to get a mortgage right now, fix any mistakes.

4.  Work to improve your credit score.