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So what, it's just a foreclosure

Getting a mortgage after a foreclosure or short-sale is not as easy as you may think
Getting a mortgage after a foreclosure or short-sale is not as easy as you may think

Recently there have been rumors circulating that someone who short-sells his house, or allows his home to go into foreclosure can simply buy a new home in as little as two years.  

With Southern California facing a flood of foreclosures, some financial professionals, real-estate agents, mortgage-brokers, and mortgage negotiators, who didn't even know what the foreclosure process was 36 months ago are now self-proclaimed experts on the subject. 

Contrary to the speculation circulating around finance blogs and real-estate offices, walking out on a home and the attached mortgage has serious consequences.  A damaged credit score may just be the beginning.

Many borrowers who did not understand the complexities of their interest-only loans may no longer be able to afford their house due to rate adjustments.  Additionally, many borrowers who can afford their monthly payment are simply making a financial decision to walk away from a bad investment.  Although there were some companies that participated in indefensible predatory lending practices, a majority of homeowners were aware of the risks associated with their home-loan and the banks know this. 

Consider the homeowner who is comfortably making payments on his $500,000 loan when he knows his house is reasonably only worth $400,000.  This borrower may assume there is no chance to recover this lost equity, and hence he makes the financial decision to walk away.  Knowing that his credit score will suffer, but assuming he will be able to rebuild and purchase a new home in a few years, this looks like the right financial choice.

To the contrary, consumers should not count on banks to take pity on them in the future simply because they walked away from their home in those financially troubled times of 2008-2011.   

Some homeowners who default on their mortgage due to provable hardships such as job loss, divorce, or medical issues may obtain an exception to buy another home in 3-5 years.  Those who voluntarily walk away from their property or short sell their residence will generally have to wait 5-10 years before a bank will consider them for a new home loan. 

Although exact numbers are not released by the credit bureaus, some consumer groups estimate a foreclosure or short-sale will affect the credit rating of a 'good' consumer by 80-100 points.  This decrease in credit score can make it difficult, and sometimes impossible, to secure financing on a car, rent an apartment, sign up for new utility services, or secure a cell phone. 

After the foreclosure process, a consumer who pays his bills on time over the course of five years has an excellent chance to raise his credit score significantly.  Unfortunately, a credit score is only one component in the mortgage underwriting process. 

Ability and willingness to continue to pay ones mortgage will be a key factor in future home-mortgage underwriting decisions.  A credit score is key to bank underwriting matrices.  Yet it is the consumer's overall credit repayment history that underwriters are really looking to when making a mortgage decision. 

Speaking to CNN, Bill Merrell of the National Association of Mortgage Underwriters states, "If you made a strategic decision to default on paying your mortgage, it will work against you [on future applications]."

No one knows what underwriting criteria will be used in the next five to six months, much less five to six years, will look like. It is however reasonable to assume anyone who defaulted on a mortgage will be subject to stricter underwriting criteria.   

Increased down payments, lower debt-to-income approval ratios, and a higher interest rate to compensate for risk are all items that banks may seek from borrowers who have a default on their record. 

For some homeowners a foreclosure or a short sale is truly the last and best option.  However, before walking away from a home, consumers should carefully weigh the consequences of this decision. 


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