There's an interesting phenomenon happening in the real estate buying cycle. Now that most of the country is five to seven years out from its real estate peak, and most major cities are actually into the upswing of home prices, distressed homeowners of yesteryear are becoming the home buyers of today.
Rules for qualifying for a mortgage vary widely between lenders and loan programs, but one of the most-often used loans today is the FHA mortgage.
Today's FHA mortgage requirements for foreclosures and bankruptcies (see your lender for exact details):
- A foreclosure that was discharged three years ago
- A bankruptcy discharged two years ago
The initial reaction by many to this situation is: Again? We've certainly all seen enough shoddy lending and lax credit practices during the last boom-bust cycle and, on the face of it, this seems like an invitation to more.
However, the details of how these home buyers must qualify diverges widely from the way sub-prime home buyers were qualifying for loans in the past. The new practices, while still generous to the buyer, create far greater protections for the lender and the American public who, in the long run, foot the bill for defaults.
Home buyers with foreclosures and bankruptcies on their records need to show a consistent history of pristine credit since the time of their foreclosure.
Additional FHA requirements (there are more, refer to a lender):
- On-time bill payment on all credit accounts since the foreclosure/bankruptcy
- A 640 credit score (responsible credit use is absolutely essential to gain this score 3 years out of foreclosure)
- A verified down payment (3.5% or higher, depending on the borrower)
- Upfront and ongoing mortgage insurance (which protects the lender from debts in case the buyer defaults)
- Significantly lower debt-to-income ratios (ensures the buyer has ample discretionary income to make payments long-term)
Underwriters scrutinize these borrowers' loan applications far more than an average home buyer. In contrast, during the real estate boom, a buyer could be approved for a mortgage with very little credit history to support it.
Sub-prime mortgage approvals at the height of the real estate boom:
- 580 credit score
- 100% Financing or 80/20 1st/2nd mortgages (no money down)
- Foreclosure 2 years out
- Bankruptcy 2 years out
- No income verification
- Total debt ratios up to 60%
While the changes in lending to borrowers who have past foreclosures and bankruptcies may not satisfy all critics, there are also mitigating factors that underwriters take into consideration. Remember that even though a home buyer's past foreclosure may have been closed as of three years ago, the banks sometimes take up to a couple of years to push a foreclosure through. That person may have essentially handed the home back to the bank five years ago and been repairing their credit ever since. Underwriters can take this into account.
Moreover, there are many different situations that lead to foreclosure. Certainly some buyers overspent, got in over their heads, and walked away from a bad investment. Those are going to be viewed less favorably by a lender. Others have lost their homes due to job loss, divorce, deaths in the family, and a host of other reasons.
When an underwriter can see that home buyers have been responsible with credit in every instance of their lives except for under one unforeseen loss of income or spouse, there is great reason to believe that these people, under the newer, more restrictive lending guidelines, are a good credit risk. The lender and the public are protected by these buyers paying for mortgage insurance, and their re-introduction to the housing market in a new economy will allow them to re-establish a long-term credit track record and keep the housing market moving.