In the past, borrowers who wanted to obtain an FHA loan after a foreclosure had to wait three years, on average.
But a rule change announced recently by the Department of Housing and Urban Development (HUD) could allow such borrowers to get an FHA loan in as little as 12 months after a foreclosure. The key caveat is that it must have been an isolated event.
An FHA loan is a government-insured mortgage. They are generated in the private sector like any other type of mortgage loan. What makes the program unique is the insurance associated with it.
The Federal Housing Administration (FHA) insures the lender against financial losses that may arise if the borrower defaults on the mortgage obligation. This is what separates FHA loans from conventional or “regular” mortgages.
FHA Loan After Foreclosure: Rules Revised in August 2013
HUD establishes all rules and requirements for this program, including the rules for borrowers who have been through a foreclosure in the past. A HUD press release from January 30, 2013 said the following:
“Borrowers are currently able to access FHA-insured financing no sooner than three years after they have experienced a foreclosure, but only if they have re-established good credit and qualify for an FHA loan in accordance with FHA’s fully documented underwriting requirements.”
The purpose of the press release was to clarify the three-year rule, which had been in effect for several years. But then, in August 2013, the rule was further revised to relax the three-year requirement. This was done with the publication of HUD Mortgagee Letter 2013-26.
On August 15, 2013, HUD revised the post-foreclosure rule so that lenders could consider extenuating circumstances that may have caused the foreclosure. HUD Mortgagee Letter 2013-26 says that borrowers may qualify for an FHA-insured loan within 12 months of foreclosure, if [and here's the key caveat] the lender can document some kind of extenuating circumstances that caused the event.
This change also applies to short sales.
Key Criteria for the ‘Economic Event’ Exception
The aforementioned Mortgagee Letter explains the requirements for getting an FHA loan after foreclosure. Here’s an overview of the requirements found in that letter:
- The mortgage lender must verify the delinquencies (missed payments) that led up to the foreclosure were the result of an ‘Economic Event.’ In this context, an Economic Event is something beyond the borrower’s control that results in employment loss, income loss, or a combination of both.
- The Economic Event must have reduced the borrower’s household income by 20% or more for a period of at least six months. FHA-approved mortgage lenders must verify and document this income reduction.
- Lenders can use a variety of documents for this purpose, including tax returns, W-2 forms, termination notices, employment letters and the like.
- The borrower must have reestablished satisfactory credit for a minimum of 12 months after the foreclosure. This means no late payment or “major derogatory credit issues” on housing debts or revolving accounts (credit cards).
- The borrower must complete at least one hour of HUD-approved housing counseling.
- The counseling session(s) must address the factors that led to foreclosure, as well as steps that can be taken to prevent it from happening again.
- Counseling sessions can be conducted in person, online, over the phone, or via Skype.
Again, this rule change makes it easier for borrowers to qualify for an FHA loan after foreclosure. Borrowers who meet the extenuating circumstances criteria outlined in Mortgagee Letter 2013-26 may not have to wait as long to get an FHA-insured mortgage. In fact, it could happen in as little as 12 months, if the foreclosure was the result of an Economic Event beyond the borrower’s ability to control.
Getting Your Credit Back on Track
What can you do to increase your chances of getting an FHA loan after foreclosure? Obviously, you can’t remove the event from your credit report. It will stay on your report for up to seven years. But you can restore your credit by paying all of your bills on time, going forward. This will improve your chances of getting approved more than any other single action.
With this rule change, borrowers may not have to wait as long to qualify for an FHA loan after foreclosure. But that doesn’t mean lenders will relax their other standards for loan approval. In fact, the Mortgagee Letter clearly states that borrowers must meet all other HUD requirements for financing, in addition to those mentioned above.