Recovering From a Short Sale


Borrowers who owe more than their homes are worth can sometimes get out from under by negotiating a short sale with their lender. But short-sellers are branded as higher-risk borrowers, so new loans won’t come quickly or easily.

A short sale is when a lender agrees to accept less than is owed on a property, allowing the borrower to walk away and avoid foreclosure. Fannie Mae, the federally controlled mortgage investor, sets guidelines for the minimum amount of time that must elapse before a short-seller is eligible for another loan salable to the agency.

Fannie Mae requires a waiting period of at least four years for short-sellers who can only put down 10 percent on their next home. The waiting period is shortened to two years for borrowers who can come up with 20 percent.

The forced waiting period is essentially a penalty on borrowers who didn’t fully repay a previous loan. And lenders who sell their loans on the secondary market are unlikely to shorten Fannie’s minimums, said Myron Headen, a senior vice president in the residential mortgage division of Bryn Mawr Trust in Pennsylvania.

“It wouldn’t matter if you were going to put 30 or 40 percent down,” he said. “You still have to meet that two-year waiting period.”

He noted, however, that Fannie does allow the four-year period to be cut in half for borrowers who can document that their loan default was a result of “extenuating circumstances.” The agency defines these circumstances as one-time events that were beyond a borrower’s control, such as job loss, medical bills, or a financial hit from divorce. Borrowers must also be able to show that they had no reasonable option other than to default.

The Federal Housing Administration, which insures low-down-payment loans, also has a “Back to Work” program that extends borrowing privileges to otherwise ineligible applicants who can prove that their past financial problems were the result of hardship, and that they have re-established satisfactory credit for the last year.

Short-sellers who hope to someday obtain another mortgage should pay careful attention to their credit while riding out the forced waiting period, said Tom Showalter, the chief analytics officer at Digital Risk, which provides mortgage services and risk analytics to lenders.

Sometimes when people are relieved of a hefty mortgage they go into “whoopee mode” and run up their credit cards or take out a car loan, he said. But shopping around for more credit after a short sale could further harm credit scores.

Mr. Showalter recommends frugal management of revolving credit so that outstanding balances do not exceed 30 percent of the borrower’s credit limit. And borrowers should stay current on all of their credit obligations.

In preparation for applying for a new mortgage, borrowers should keep detailed records of income sources. New regulations require lenders to prove borrowers’ ability to pay, and “the more documentation you can offer, the more the originator can go to bat for you,” Mr. Showalter said. When it comes to liabilities, applicants should be forthcoming and not try to hide obligations like alimony or child support.

Short-sellers getting back into the housing market would be wise to think smaller, especially in a still-shaky economy. And, Mr. Showalter advises, they should “avoid like the plague” loans requiring very little or no money down.

“If the appraisal is at all off or the property suffers some depreciation, and you have an income hiccup, then you can’t get out of that property,” he said. At least, that is, not without another short sale.

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