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Jan 11, 2020 | By
How to Buy a House After Foreclosure

How to Buy a House After Foreclosure

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Did you lose your house in foreclosure?

Perhaps you lost your job or had something happen that's out of your control. Whatever the case may be, life happens, and people make mistakes. Fortunately, buying a house again after a foreclosure is possible.

Getting approved for a mortgage may take a little more work and time, but with the right steps, you can qualify for a mortgage again.

Keep reading to learn how.

Getting a mortgage after a foreclosure

Many people think that once they have a foreclosure, they can never purchase a house again. Luckily that's not the case. It is possible to get another mortgage. Getting a mortgage immediately after a foreclosure is not realistic, though. You will have to wait a bit of time to show lenders that you are back on your feet.

There are several different types of mortgages. Each one has their waiting requirements. The longest you'd have to wait is seven years, but many programs have shorter wait times and even flexible guidelines.

Government home loans have the shortest waiting period. On average, you'll wait two to three years after a foreclosure with the right circumstances:

  • FHA loans -3-year waiting period
  • VA loans -2-year waiting period
  • USDA loans -3-year waiting period

Conventional loans have a 7-year waiting period and the strictest underwriting requirements. Some lenders may allow a conventional loan after three years, but you must prove extenuating circumstances and get lender approval. Conventional loans have the most stringent guidelines.

Non-QM Loans

Sometimes standard loan programs don't work. Non-QM loans offer options, though. Non-QM loans don't follow specific guidelines. Lenders write their own 'rules' for these loans and base it on a case-by-case basis. In other words, you may get a loan with a shorter waiting period and flexible underwriting guidelines. However, the interest rates on QM loans are usually higher than the standard loan programs mentioned above.

Work on your credit

It's essential to use the required waiting period wisely if you want to buy a house after foreclosure.

Each loan program has a credit score, debt ratio, and down payment requirements that take time to achieve.

Repairing your credit should be a top priority during this time.

Use the following tips to help:

  • Get current on your payments - If you fell behind on any payments, get caught up. With regular on-time payments, your credit score will increase.
  • Pay credit card debt down - Keep outstanding debts to a minimum. Pay credit card debts down or off entirely and pay down any other installment debts.
  • Pay off collections - Pay off any outstanding collections. They won't quickly disappear from your credit report, but you can show lenders that you are a responsible person by getting rid of them. Usually, this requires some payment agreement with the creditor or settlement agreement.
  • Don't open new accounts - Opening new accounts brings your average credit age down, which isn't good for your credit score. New debt also increases your debt-to-income ratio. We only recommend opening up new accounts if you don't have any.
  • Don't close old accounts - Closing old accounts also lowers your average credit age. Leave the accounts open, just unused.
More info: FHA loan credit requirements and How to improve your credit score

Start working on your housing history

Lenders need to see that you're able to make a housing payment.

You may have to show proof that you've made rent payments on time for the last 12 months (24 months for VA loans). Keep copies of your canceled rent checks, so they are easily accessible when the time comes.

Avoid paying cash for housing payments. Cash will make the mortgage process difficult for you as there will be loads of paperwork and letters needed.

Stabilize Your Employment

Your employment and income is an integral part of the loan approval process.

Generally, lenders like to see a 2-year history at the same job. This shows stability and predictability. If you don't have a consistent 2-year employment history in the same position, try staying within the same industry. This helps with the 'consistency' requirement lenders need.

Your income also affects your debt-to-income ratio. Paying your debts down may help, but you also need adequate income. Each loan program has specific debt-to-income ratios you must meet:

  • FHA loans - 41% total debt ratio (can go higher, but would require a full pre-approval review to determine if it is possible)
  • VA loans - 41% total debt ratio (can go higher, but would require a full pre-approval review to determine if it is possible)
  • USDA loans - 41% total debt ratio (this is the max DTI allowed on a USDA loan)
  • Conventional loans - 41% total debt ratio (can go higher, but would require a full pre-approval review to determine if it is possible)
  • Non-QM Loans - 46% total debt ratio

Your debt-to-income ratio compares your gross monthly income (income before taxes) to your monthly obligations. It's crucial to meet these ratios, especially after a foreclosure.

For example, if you need FHA financing, your new housing payment shouldn't take up more than 31% of your gross monthly income. Your total monthly debts also shouldn't exceed 41% of your gross monthly income.

However, depending on your credit score, you may be able to go up to a 50% DTI with an FHA loan.

The lower your DTI, the lower the risk you pose to a lender. This increases your chances of a pre-approval.

Save for a Down Payment and Reserves

Before the foreclosure, you may have gotten away with a low down payment.

After foreclosure, lenders need more reassurance of your ability to repay the loan. They need the stability of the down payment or 'skin in the game.'

Investing your own money in the home shows lenders you are serious about owning a home again. With your own money invested, you're less likely to fall behind (to the best of your ability). The only exception is a VA loan. VA loans don't require a down payment.

In addition to your down payment, it's a good idea to have some money saved up. Depending on your file, the underwriter may require you to have at least one month to 3 months of the mortgage payment sitting in your account.

Also when purchasing a home, there are inspections required like an appraisal or home inspection. There are also buyer closing costs. These closing costs can range between 3% to 5% depending on the purchase price, time of year, and the state you are purchasing in.

If you can't cover the closing costs, you may be able to negotiate the seller's assistance into the purchase contract.

If you can, try saving up money. Lenders like to see 'extra' funds on hand to cover the mortgage payment and unexpected costs.

Read more: How to save for a down payment

Write a Letter of Explanation

Your final step is a personal one. Lenders can look at your credit report, income, employment, and assets all they want, but they'll never know the real reason behind what happened. A Letter of Explanation written by you helps explain the situation.

In your letter, include details of why you fell behind on your mortgage and what you've done to pick up the pieces. Show lenders that you've improved your situation. Include proof too. For example, if you fell ill and had to stop working for six months, show your tax returns or W2s with the lower-income, and explain how the illness affected your ability to work and also provide any medical bills to support your story.

Also, show the proof that you've recovered, are back to work, and have higher and stable income now. The more details you can include in the letter, the more likely it will help your situation.

How hard is it to buy a house after foreclosure

You may have to jump through a few hoops to get a mortgage after foreclosure, but it's possible. If you don't qualify for a conventional loan right away, don't worry.

Get the loan that you can be eligible for and afford for now. As you continually improve your credit and as time passes since the foreclosure, you can refinance the new loan into a conventional loan in the future.

To determine if you qualify now, talk to one of our home loan experts by filling out this loan application. Checking to see if you are eligible won't hurt your credit score.

Statistics on homeowners facing foreclosure

  • 1 out of every 200 homes will be foreclosed on.
  • Every three months, 250,000 new families enter into foreclosure.
  • One child in every classroom in the US is at risk of losing his/her home because their parents are unable to pay the mortgage.
  • 6 in 10 homeowners wish they understood the terms and details of their mortgage better.
More info: FDIC facts on foreclosures

Read on: Mortgage pre-approval - You'll need it!

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