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Losing a home to foreclosure can hit hard, both emotionally and financially. But having suffered a foreclosure doesn't limit you to renting for the rest of your life. The impact of a foreclosure on your credit will gradually lessen until the foreclosure eventually drops off your credit report. You can buy a home after foreclosure if your credit score has improved and your finances are in good shape. Here's how to get your credit ready to buy a home after a foreclosure.
How Foreclosure Affects Your Credit
Lenders consider a foreclosure to be a serious derogatory event on your credit report. (Only bankruptcy is worse.) Generally, banks don't start foreclosure proceedings until you have missed four mortgage payments. Missing that many payments could reduce your credit score by over 100 points even before the foreclosure. If you're also falling behind on other bills, your score could drop even more. The higher your credit score was to begin with, the worse the impact of foreclosure.
A foreclosure will stay on your credit report for seven years after the first missed mortgage payment, and you can't get a legitimate foreclosure removed from your credit history before then. While having a foreclosure on your credit report will lower your score, its impact could lessen over time if you're keeping up with your other bills.
Loan Foreclosure Waiting Periods
Even if your credit has improved, having a foreclosure on your credit report will impose a waiting period that restricts when you can qualify for certain types of mortgages. Here are three types of mortgages whose waiting periods range from two to seven years.
Fannie Mae and Freddie Mac
Conventional mortgage loans follow rules set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). You'll have to go through a mandatory seven-year waiting period after foreclosure before you can get a Fannie Mae- or Freddie Mac-backed loan.
You may be able to get the waiting period reduced to three years if you can prove extenuating circumstances. These are defined as one-time events beyond your control that significantly reduced your income or greatly increased your expenses. Examples include a divorce, a major illness (and accompanying medical bills) or a job layoff. You'll need to provide documentation of the extenuating circumstances.
The waiting period for a Federal Housing Administration (FHA)-backed mortgage is typically three years from the completion of the foreclosure action. You may qualify for an exception to the FHA loan waiting period if you can prove that the foreclosure was due to extenuating circumstances outside your control.
Getting a home loan backed by the Department of Veterans Affairs (VA) after foreclosure typically involves a two-year mandatory waiting period. However, depending on the lender, you may also be able to get a mortgage sooner if you can prove financial hardship.
How to Buy a Home After a Foreclosure
To buy a home after a foreclosure, you'll need to do three things.
Wait for Time to Pass
Buying a home after a foreclosure is largely a waiting game. As mentioned above, you may need to wait up to seven years for the foreclosure to drop off your credit report, depending on the lender and the type of mortgage you're seeking. Proving extenuating circumstances can shorten the wait.
Rebuild Your Credit
While you're in a waiting period, use the time to work on improving your credit and saving for a down payment. You typically need a FICO® Score☉ of at least 620 to qualify for a conventional mortgage or VA loan. FHA mortgage criteria are more lenient; depending on your down payment, you may qualify for an FHA loan with a FICO® Score as low as 500. Shop around and you'll find lenders offering options for a range of credit scores, including subprime mortgages for those with lower credit scores.
To get your credit ready for a mortgage:
- Pay down debt and avoid taking on new debt. When considering your mortgage application, lenders look at your debt-to-income ratio—how much monthly debt you have relative to your income. They'll also examine your credit utilization ratio, or how much of your available credit card you're currently using. Aim to pay down debt and keep your credit card balances—both on each card, and in total—below 30% of your available credit line.
- Avoid large purchases. Lenders look at your savings to see if you have a financial cushion. Instead of spending that cash, save it for your down payment so you can borrow less—and possibly land a lower interest rate too.
- Pay bills on time. On-time payments are the single biggest factor in your FICO® Score, and just one late payment in the 12 months before you apply for a mortgage is a major warning sign for lenders. Do whatever you can to ensure you never miss a due date, such as setting up autopay or using reminders on your calendar or phone.
- Don't apply for new credit. Every loan or credit card application generates a hard inquiry on your credit report, which can negatively affect your score. Although the impact is short-lived, it's best to avoid anything that can lower your credit score when you're preparing to apply for a mortgage.
- Sign up for Experian Boost®ø. This free service adds your utility, cellphone and streaming accounts to your Experian credit report. Paying those bills on time could boost your credit score quickly.
Improve Your Spending Habits
In addition to rebuilding your credit, you may work on a new attitude toward money. Take an honest look at your pre-foreclosure financial habits to uncover the reasons for the foreclosure. Were you overspending? Did credit card debt spiral out of control? Did you buy more house than your budget allowed?
Work on building an emergency fund to help you in a future financial crisis. Also create a budget to figure out how big of a mortgage payment you can reasonably manage. Don't forget to account for the other expenses of homeownership, such as home insurance, property taxes, maintenance and repairs.
A Second Try at Home Ownership
When you believe you're ready to buy a home again, check your credit report and credit score to make sure you're in good shape. Then, shop around to compare mortgage terms, including interest rates, closing costs and fees. Working with a mortgage broker can also help you find the best loan terms for your situation.
You can give yourself an edge with sellers by getting preapproved for a mortgage. You may want to apply with several lenders to do this. If so, complete all your applications within a few weeks so credit bureaus will treat them all as one credit inquiry. It takes hard work and patience to buy a house after having a foreclosure, but your efforts will pay off when the key to your new home is in your hands.