If you lost your home in foreclosure, you probably think you are out of luck. No lender will want to give you another loan, right? Wrong. There are lenders that will give you a second chance. They can recognize when a borrower has bounced back and recovered from the issue that occurred. FHA loans are among the most forgiving, but how long do you have to wait?
The FHA requires that you wait three years from the date of the foreclosure closing. The three years don’t start until the foreclosure process ends. It’s not when you get that first letter telling you that the lender is starting foreclosure proceedings. It starts the date that the bank takes possession of the home. Once those three years are up, you can apply for an FHA loan again.
Improving Your Credit During Those Three Years
While three years may seem like a long time, think of it as a gift. It’s the gift of time for you to improve your credit. Chances are that your credit score took a big hit when you lost your home in foreclosure. Now you have to bring things back to ‘normal.’
First, figure out why you experienced a foreclosure. What happened that made you unable to make your mortgage payments? Do some soul searching if the reason isn’t super obvious. For example:
- Did you lose your job?
- Did you fall ill and were unable to work?
- Did your spouse lose his/her job?
- Did your payment increase due to being on an adjustable mortgage?
- Did you just overspend?
Knowing the reason you were unable to afford your mortgage payments any longer will help give you some insight. If you lost your job, the obvious answer is to find another job. You want to find a job with income that is equal to or more than what you were making before. If that doesn’t happen, you may want to take on a second job or side gig to make up the difference.
If you lost your home for reasons outside of your control, such as falling ill, just give it time. Slowly start paying your past due bills and getting current on them. Pay your loan or credit card balances down as much as you can. Talk to your spouse about getting another job. Consider another type of mortgage, such as a fixed rate rather than an ARM.
If you just overspent, you are going to have some explaining to do to a new lender. The other scenarios are easily explained. Overspending shows a lender that you are irresponsible. It’s up to you to show the lender that you have made that a part of your past and that you are ready to move on with good financial habits.
Lower Your Debt Ratio
As much as a high credit score can help you get an FHA loan after foreclosure, lenders are going to pay close attention to your debt ratio too. They want to know that you aren’t overextended. They can see what happens when you get overextended – you default on your loan and eventually lose your house. That’s the last thing the FHA wants to happen to you again.
Work on your credit card balances. Can you pay them off in full? Sometimes not having any debt is better than having a savings account. You can show lenders that your monthly income is overly taxed. This way you can easily make your mortgage payments and restock your savings account. The same goes for installment loans or other debts that you have outstanding. The fewer debts that you have when you apply for the loan, the better your chances of approval become.
The FHA’s Basic Guidelines
It helps to know what FHA lenders look for when approving borrowers for a loan.
- Minimum 580 credit score
- Maximum housing ratio of 31%
- Maximum total debt ratio of 43%
- Stable income and employment for the last 2 years
In addition, since you had a foreclosure before, lenders may want to see some compensating factors from you. These factors make up for the foreclosure. In other words, they make you a lower risk of default. The most common compensating factors include:
- Reserves on hand – If you have liquid assets, such as checking, savings, stocks, or bonds, they can be a compensating factor. Lenders count your reserves by the number of months of mortgage payments they can cover. If your loan payment is $1,000 and you have $10,000, you have 10 months of reserves.
- Increasing income – If you can show a steady progression of increasing income over the past few years, it can count as a compensating factor. Lenders like consistency in employment and increasing income. They show a lender that you are reliable and not a high risk of default.
- High credit score – Even though the FHA allows credit scores as low as 580, lenders prefer the scores to be much higher. If you can pull off a credit score in the 700s or at least near it, you may have a better chance of approval despite the foreclosure in your past.
The FHA loan is one of the most forgiving programs available today. Make sure that you shop around with different lenders in order to get the best rate and terms on a mortgage loan after foreclosure.