The Department of Housing and Urban Development (HUD) recently announced a rule change for borrowers who have been through foreclosure, short sale, deed in lieu of foreclosure, or bankruptcy in the past.
Previously, such borrowers had to wait at least three years before they could qualify for an FHA loan, with a few exceptions. The revised rule for 2014 creates a set of extenuating circumstances that could allow borrowers to get an FHA loan one year after a bankruptcy or foreclosure-related event.
This is a significant change in policy that could affect a large number of borrowers. It will likely lead to an increase in the FHA’s market share, which has already increased significantly since the housing crisis.
All of the pertinent details can be found in HUD Mortgagee Letter 2013-26, dated August 15, 2013. Here’s an overview of the 2014 requirements and restrictions for using an FHA loan after bankruptcy or foreclosure.
Introduction: The Rise of Bankruptcy, Foreclosure and Short Sales
The recession put millions of homeowners in a situation where they could no longer afford their mortgage payments. As a result, foreclosures, short sales and bankruptcies rose sharply during the recession years.
The Federal Housing Administration (FHA) realizes that many people in this situation are generally responsible with their finances. They were victims of a once-in-a-lifetime economic catastrophe that was largely beyond their control. Their foreclosures, short sales and bankruptcies were isolated events.
To that end, FHA is changing the rules for borrowers who want to use an FHA loan after a bankruptcy, short sale, foreclosure, or deed in lieu of foreclosure. In 2014, borrowers who can show that the negative event was due to income losses beyond their control could be eligible for an FHA loan within one year of the event. This is a major change over the previous three-year rule for bankruptcies and foreclosures.
New Rule for 2014: Getting an FHA Loan After a Negative Event
Borrowers who are ineligible for an FHA loan due to the existing waiting period for short sales, foreclosures, deeds-in-lieu and bankruptcies may qualify for the program in 2014, under the following conditions:
- The borrower can provide documentation to show that the delinquencies or default were the result of an ‘Economic Event’ beyond their control. See definition of Economic Event below.
- The borrower has completed an approved counseling program. See requirements below.
- The borrower meets all of HUD’s other guidelines for FHA loan eligibility.
Applicants who meet these criteria could qualify for an FHA loan in as little as 12 months after bankruptcy, short sale, foreclosure, or deed in lieu of foreclosure.
Definition of an ‘Economic Event’
In this context, an Economic Event is something beyond the borrower’s control that results in income loss, job loss or both. The Economic Event must have reduced the borrower’s household income by 20% or more for at least six months. To qualify for an FHA loan, borrowers must have re-established Satisfactory Credit for at least 12 months.
Definition of ‘Satisfactory Credit’
Borrowers who wish to use an FHA loan after a foreclosure, deed in lieu, short sale or bankruptcy in 2014 must be able to demonstrate Satisfactory Credit after the Economic Event (loss of job / income). Here’s how HUD defines ‘Satisfactory Credit':
- The borrower’s credit report does not show any late payments on mortgage or revolving credit accounts.
- Mortgages must be current with a history of at least 12 months of satisfactory payments.
- Temporary and permanent loan modifications are acceptable, as long as the payments have been documented and made on time in accordance with the modification agreement.
- The borrower meets all other requirements outlined in HUD Mortgagee Letter 2013-26.
Lender Verification and Documentation Requirements
Lenders must obtain and verify documents that show the borrower’s household income was reduced by 20% or more for at least six months, as a result of the Economic Event. Lenders can use a variety of documents for this purpose, including: Verification of Employment (VOE) documents, termination notices, business closure notices, tax returns, and W-2 forms.
The key to all of this: Lenders must review the borrower’s credit history to ensure (A) the derogatory credit was the result of an isolated Economic Event, and (B) the borrower has a history of Satisfactory Credit before and after the event. In other words, the derogatory credit must have occurred after the onset of the Economic Event, and the borrower must have returned to a pattern of responsible payments for a minimum of 12 months.
In 2014, borrowers who wish to qualify for an FHA loan after bankruptcy, foreclosure, short sale, deed in lieu of foreclosure, or other derogatory events must reestablish Satisfactory Credit for at least 12 months. Lenders must verify that this minimum time frame has been bet.
In most cases, the requirement is that 12 months have elapsed since the date of the event (foreclosure, short sale, deed in lieu). Bankruptcies are a bit different:
- For Chapter 7 Bankruptcy, 12 months must have elapsed since the date on which the bankruptcy was discharged.
- For Chapter 13, the requirement is that the bankruptcy was “discharged prior to loan application and all required bankruptcy payments were made on-time, or a minimum of 12 months of the pay-out period under the bankruptcy has elapsed and all required bankruptcy payments were made on time.”
Counseling for FHA Borrowers With Bankruptcies, Foreclosures, etc.
The revised FHA rule also has an educational component. To be approved for an FHA loan after a foreclosure, deed in lieu of foreclosure, short sale or bankruptcy, borrowers must also undergo housing counseling. Such counseling is designed to help borrowers understand their mortgage options, create a housing budget, avoid common scams and more. Here are the minimum requirements:
- Borrowers must receive at least one hour of one-on-one counseling from a HUD-approved counseling agency.
- The counseling must address the cause of the foreclosure, short sale or bankruptcy, as well as actions that can be taken to reduce the chance of it happening again.
- Counseling must be completed at least 30 days, but not more than six months, before the loan application is submitted.
- Counseling may be conducted online, via Skype, over the phone, in person, or through other HUD-approved methods.
This is a simplified overview of the revised rule. Borrowers who wish to qualify for an FHA-insured mortgage after a foreclosure, short sale or bankruptcy in 2014 should refer to Mortgagee Letter 2013-26 for more information. Borrowers can also call the FHA Resource Center at 1-800-CALLFHA (1-800-225-5342).