Can I get a mortgage after a short sale of my home?

Key takeaways

• Selling your home through a short sale can help you avoid foreclosure, but it might make it difficult to get another mortgage.

• Short sales can damage your credit, and they can stay on your credit report for seven years.

• You might pay higher rates on future mortgages after a short sale.

If you’re having trouble making mortgage payments or you’re underwater on your home, it may be possible to pursue a short sale. This process helps you avoid foreclosure by selling your home for less than the amount still owed on the loan, while having the remainder forgiven. But there are drawbacks, too, including the fact that short sales can impact your ability to buy a home in the future. Here’s what to know about getting a mortgage after a short sale.

The impact of a short sale on your credit

There are many reasons why you might choose to sell your home through a short sale, a process in which your lender allows the home to be sold for less than what’s owed on the mortgage. But no matter what the cause, the impact is the same: A short sale damages your credit. It also remains on your credit report for up to seven years.

While the exact amount your credit score declines depends on your credit history and the type of scoring system a credit agency uses, it can often drop between 100 and 150 points. Those with a higher score initially are likely to see a greater decline.

The change in your credit score will make it difficult to qualify for loans in the future — but not impossible. In cases where you are able to qualify for a loan, though, you’ll likely pay a higher interest rate.

Rebuilding credit after a short sale

Since short sales damage your credit score, pursuing a home loan after a short sale may be a lengthy process with a required waiting period. If you want to buy a home in the future, you’ll need to repair your credit to be eligible for the best interest rates and loan programs possible.

“If a short sale is the only blemish on your credit report, you should be able to rebuild your credit relatively quickly during your waiting period,” says Steve Nakash, managing director at FBC Mortgage in Denver, Colorado.

Here are some steps that can help boost your score:

• Review your credit report at AnnualCreditReport.com, and correct any errors or problems you spot.

• Pay off your existing debt as best you can.

• Avoid making late payments and keep your credit utilization low — below 30 percent if possible.

• Avoid applying for two or more credit accounts in a short time. It’s best to separate your applications by a few months, so that your credit isn’t dinged by multiple inquiries.

• Don’t close unused credit cards. You can also consider applying for other new lines of credit, but only if you intend to make payments on time and use them responsibly.

• Determine how long it will take you to save up for the minimum down payment needed on your next loan, and work diligently toward that goal.

• Shop around for loans with at least three lenders, and compare rates and terms.

Minimum waiting periods to get a mortgage after a short sale

How long after a short sale you must wait to buy a house depends on the loan type. There are minimum waiting periods before seeking a new mortgage or refinancing after a short sale. Note that these are general requirements and may vary depending on your financial situation.

• Conventional loan: You could qualify for a conventional loan after a short sale in as little as two years, but you’ll likely need to demonstrate “extenuating circumstances” that led to the sale, such as job loss.

• FHA loan: The short sale waiting period on FHA loans is typically three years, unless you can prove extenuating circumstances, which could shorten the wait to one year. You may also be able to apply for a mortgage with no wait whatsoever if you weren’t in default on your prior mortgage at the time of sale, and you paid it on time in the year before the sale.

• USDA loan: With a USDA loan, you’ll generally have to wait three years to apply for a new mortgage, even if extenuating circumstances contributed to the short sale.

• VA loan: At two years, VA loans have the shortest waiting period, and there may even be no wait at all if you made payments on time before the sale.

• Non-qualifying mortgage (non-QM): For a non-qualifying mortgage, there may be no waiting period. But keep in mind that these loans can require a larger down payment and charge higher interest rates than other types.

Extenuating circumstances that might shorten the waiting period

Fannie Mae defines extenuating circumstances as “nonrecurring events that are beyond the borrower’s control that result in a sudden, significant and prolonged reduction in income or a catastrophic increase in financial obligations.”

If extenuating circumstances led to your short sale, your lender might reduce your waiting period for a new loan. Extenuating circumstances may include:

• Divorce

• Death or serious illness of someone in the household (typically the main wage earner)

• Loss of employment or household income

To qualify for a shortened waiting period, you’ll need documentation that explains how the extenuating circumstances contributed to your short sale. For example, if you suffered a major medical event that prevented you from working, you might provide medical reports and bills.

“Bad things sometimes happen to good people,” says Nakash. “Bankruptcies occur, people lose their jobs, people get sick. That’s why it’s always smart to have six months of emergency funds on hand to weather these types of situations.”

If you’re unsure whether your situation qualifies as extenuating circumstances or need more information about which documents to provide, contact your lender.

How to get a mortgage after a short sale

You can qualify for a new mortgage after a short sale, but it can be difficult and more time-consuming. You may see higher mortgage rates, too.

“When you do try to get another mortgage, realize that lenders are going to be more cautious,” says Nakash. “You now have a history of not being able to pay. Lenders will scrutinize your credit after a short sale to ensure you can make the new payments.”

For instance, it may be difficult to get a conventional loan after a short sale, as lenders typically require a minimum credit score of 680. FHA loans require a score of at least 580 with a 3.5 percent down payment.

Take these five steps to get a mortgage after a short sale:

1. Focus on improving your credit: Working on your credit is the most important step after a short sale, so you can get your score back up to the minimum needed to qualify for another mortgage. This effort should include keeping debt balances to a minimum and paying all bills on time consistently.

2. Maintain steady income and employment: After a short sale, a lender will pay particular attention to making sure you have a steady history of employment and a reliable source of income to make your new mortgage payments.

3. Save enough to make a higher down payment: Coming to the table with a higher down payment for your next home can help improve your approval odds for loan approval after a short sale. After all, the more you pay upfront, the less you’ll have to borrow.

4. Know your waiting periods: Once you know what type of loan you want to apply for, find out the waiting period for your specific circumstances well in advance. You can use that time to improve your financial picture.

5. Find a lender with short sale expertise: Lenders that have a solid track record of handling short sales may be more open to lending you money for a new mortgage. Some lenders may even specialize in this type of loan.

Getting a mortgage after a short sale FAQ

• Can I get a mortgage with a low credit score after a short sale?

  Yes, you may qualify for a mortgage after a short sale — but it depends on the loan program you select, and there will be a waiting period. FHA loans are worth considering for credit-challenged borrowers once the three-year waiting period following the short sale ends: You’ll need a 580 credit score and a 3.5 percent down payment. If you can save up a 10 percent down payment for an FHA loan, you can apply with a minimum credit score of just 500.

• Should I disclose my previous short sale when applying for a new mortgage?

  Yes. It’s best to voluntarily notify your lender of the short sale on your application. If you don’t, they will find out anyway when reviewing your credit report, and that could result in an automatic mortgage denial for failing to disclose this information.

• Can I use a co-signer to help me qualify for a mortgage after a short sale?

  Yes, lenders generally do allow co-signers on mortgage loans, even if the primary borrower has a prior short sale on their credit profile. Having one can help boost your approval odds, but keep in mind that your co-signer assumes equal responsibility for the loan without having rights to the property. In short, if you default on the payments, it becomes their responsibility to keep the loan in good standing.

   

• Can I refinance my mortgage after a short sale?

  If you get a new mortgage after a short sale, it’s possible to refinance at a later date. But if your credit score hasn’t fully recovered from the short sale yet, and is still on the low side, refinancing may not make financial sense, because you could be offered less attractive terms.

Bottom line

Keep in mind that just because you can apply for a mortgage after a short sale doesn’t necessarily mean you should. A short sale can damage your credit significantly. There will almost certainly be a waiting period before you are permitted to apply for another mortgage — it’s smart to spend this time rebuilding your credit score and making sure you can demonstrate financial stability, so that you present less of a risk to mortgage lenders and can qualify for better loan terms.