I’ve written on this subject before but I want to be more thorough this time. There have been too many articles put out lately that discourage people from contemplating a home purchase after doing a short sale. These articles express cynicism about home sellers’ financial habits and cynicism from Realtors as well. Most Realtors doing short sales know how to cover the bases for their client to make sure they’re in a good position to buy a home down the road. Further, in my area (Saint Paul, MN), nearly 39% of homeowners are upside down on their home. Only a small minority of these homeowners who would do a short sale on their home have destroyed credit. All too often unfortunately, they are told that they won’t be able to buy a new home for 2-7 years and, consequently, they let their credit go. This assumption of a waiting period is not true and serves as harmful information to the homeowner doing a short sale.
Prior to December 16th of 2009 there was no FHA rule prohibiting homeowners who had a recent short sale from purchasing a home. Few took advantage of this because the lending industry was wary and wanted clarification from HUD on whether this was ok or not. On December 16th of 2009, HUD gave that clarity with Mortgagee Letter 09-52 which allows a people to buy a home after a short sale if “they were current on their mortgage and other installment debts at the time of the short sale of their previously owned property, and the proceeds from the short sale serve as payment in full.” One caveat to this; FHA will not allow the new loan if the borrower did a short sale “simply to take advantage of declining market conditions, and purchase, at a reduced price, a similar or superior property within a reasonable commuting distance.” When this rule came out, many thought that despite the fact that HUD allowed for a purchase subsequent to a short sale, no lenders would go along with it. They were wrong. Most lenders have adopted the rule as outlined in the mortgagee letter without additional underwriting guideline overlays.
But this did not deter the naysayers. They would assert that even if HUD and lender guidelines allow for it, the IRS would kill the deal. It’s true that a short sale can create a taxable event. Because I am not a CPA or a tax lawyer, I will refer you to IRS Publication 4681 which explains in detail what the tax consequences can be after a short sale. There are handy scenarios, examples and useful information of every kind. So a buyer who has a tax lien can’t buy a new home, right? Wrong.
According to the FHA mortgage credit analysis handbook 4155.1 REV-5, 2-5 (B), a homebuyer with a tax lien is eligible for a FHA loan when, “the delinquent account is brought current, paid, otherwise satisfied, or a satisfactory repayment plan is made between the borrower and the Federal agency owed and is verified in writing. Tax liens may remain unpaid provided the lien holder subordinates the tax lien to the FHA-insured mortgage. If any regular payments are to be made, they must be included in the qualifying ratios.” It goes onto read, “”Since the IRS routinely takes a second lien position without the necessity of independent documentation, eligibility for FHA mortgage insurance will not be jeopardized by outstanding IRS tax liens remaining on the property unless the lender has information that the IRS has demanded a first-lien position.” That’s right. The lien can be left unpaid and it will automatically subordinate to the new FHA loan without the need of additional paperwork.
But the naysayers are not yet done. They will say, “Oh but with a short sale and a tax lien, their credit will be obliterated. There’s just no way they’ll qualify.” All a borrower needs is a 620 middle credit score. Some lenders (I’m not one of them), will even go lower. I’m going to address this objection with an anecdote (and really, this is not an isolated incident – sadly, it happens more common than you think.) I recently had an applicant pull a 622 middle score. On this credit report was a judgment and 19 collections. That’s it. This person had defaulted on every extension of credit ever given and still pulled a 622. Not that an IRS tax lien and short sale aren’t damaging but, come on, they far from rule anything out.
My point in writing this is to serve as a reminder that in a lot of areas nearly two fifths or more of us are upside down, may want to move and are not deadbeats. Also, I wanted to get this out there to provide the facts to dispel the myth that homeowners who do a short sale are only welcome to take a timeout from homeownership. This is not their only choice. They’re welcome to continuing homeownership in the same way as the rest of us, . . . . Conditionally.
Here are some related articles on this topic that I think you might find interesting:
- Short Sales Do Not Require a Delinquent Mortggae
- Waiting Periods After Major Credit Events
- What are Extenuating Circumstances?
- Why Borrowers Buying after a Short Sale are a Good Credit Risk
- Buying a Home After a Short Sale Using VA Financing
Here are some comprehensive “waiting periods” associated with buying after a short sale:
- If you had no late payments on your installment debt and mortgage debt in the 12 months preceding your short sale, you can likely buy right now using FHA or VA financing (assuming minimum qualifications for FHA and VA).
- If there were late payments and you are VA eligible and can document extenuating circumstances, it would be a 1 year waiting period.
- If there were late payments and you aren’t VA eligible you either need a 2 year waiting period and 20 percent down or a 2 year waiting period, 10 percent down, the ability to document extenuating circumstances and an automated underwriting approval.
- If there were late payments and none of the preceding scenarios work, FHA will work after 3 years. If the preceding loan from the short sale was FHA, the 3 year waiting period would commence from the moment that FHA paid the insurance claim to the lender that received a short payoff during the sale.
- If there were late payments and you are VA eligible but couldn’t document extenuating circumstances, you could buy after 3 years so long as the previous mortgage that settled for less than the amount due wasn’t a VA mortgage because if it was, the VA eligibility would need to be restored by paying back the deficiency.
- If there were late payments and none of the preceding scenarios are workable, then the availability of conventional financing is restored after 4 years.
Charles Dailey - iLoan - NMLS ID# 79048 – CA DOC, MN DOC & WI DFI – 612.234.7283
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