Loan Modification

FHA Loans ? Fair or Unfair?

By Peter G. Miller

Are FHA guidelines wrong to make borrowers wait for several years after a bankruptcy or foreclosure?

Barbara writes and offers this situation:

“Let?s consider this scenario: You have purchased a home with private lending sub-prime hard money, all the documents are properly recorded. Due to present economic conditions, you fall behind, home falls into foreclosure, and you file BK. The mortgage is included in the BK, the automatic stay is lifted and the foreclosure concludes with the private mortgage holder now owning the property. You commence repairing your life after the BK while saving for a home of your own again. Those in the know all tell you that you have to wait at least two years after the BK before you are eligible for any type of mortgage financing. When you evaluate your credit report with a mortgage broker in anticipation of purchasing your own home again in the near future, you are told that according to FHA financing ?rules? you are unable to qualify for FHA financing until FIVE (5) YEARS AFTER the property sells because the mortgage from the private lender was never reported to the credit bureaus (it?s apparently too costly for private lenders to report). So, the private mortgage company that did not report the mortgage continues to mess with your credit for five years after the foreclosured upon home is sold. That?s just not right! Is there anything that can be done in such a situation?”

Questions

From one end to the other this example raises questions.

First, a “sub-prime hard money” means that the borrower could not qualify for a lower-cost FHA loan to purchase the property. This is a case where the buyer was likely best served by renting. The reason? A hard-money mortgage loan might have a high interest-rate (think 15 percent), a stiff downpayment requirement (think 30-35 percent) and points. The terms of such loans are so stilted that they make no economic sense for borrowers.

Second, there’s no reason for any lender to instantly approve someone who has both a foreclosure and a bankruptcy until the would-be borrower has plainly re-established their credit. An mortgage insurance plan — and that’s what the FHA mortgage program is — is equally right to set stiff standards to avoid excess risk and claims.

Third, if someone has walked-away from a mortgage commitment — a “strategically default” — then their ability to enter into a mortgage agreement is compromised by their history. The idea of “contract sanctity” is distorted by mortgage walk-aways and FHA guidelines ought to reflect that reality.

Fourth, how long one must wait to get an FHA loan depends on the facts and circumstances which lead to foreclosure and bankruptcy.

Foreclosures

HUD says “a borrower whose previous principal residence or other real property was foreclosed or has given a deed-in-lieu of foreclosure within the previous three years is generally not eligible for a new FHA-insured mortgage. However, if the foreclosure was the result of documented extenuating circumstances that were beyond the control of the borrower and the borrower has re-established good credit since the foreclosure, the lender may grant an exception to the three-year requirement. Extenuating circumstances include serious illness or death of a wage earner, but do not include the inability to sell the house because of a job transfer or relocation to another area.”

Bankruptcy

“A Chapter 7 bankruptcy (liquidation),” says HUD, “does not disqualify a borrower from obtaining an FHA mortgage if at least two years have elapsed since the date of the discharge of the bankruptcy. Additionally, the borrower must have re-established good credit or chosen not to incur new credit obligations. The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs. An elapsed period of less than two years, but not less than 12 months, may be acceptable if the borrower can show that the bankruptcy was caused by extenuating circumstances beyond his or her control and has since exhibited a documented ability to manage his or her financial affairs in a responsible manner.

“Additionally, the lender must document that the borrower’s current situation indicates that the events that led to the bankruptcy are not likely to recur. A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA mortgage provided the lender documents that one year of the payout period under the bankruptcy has elapsed and the borrower’s payment performance has been satisfactory (i.e., all required payments made on time). In addition, the borrower must receive permission from the court to enter into the mortgage transaction.”

Full post as published by FHA Mortgage Guide on August 02, 2010 (boomark / email).