Remaking the Dream

As they come back to the market, formerly foreclosed buyers will look to you for guidance.

March 14, 2013

They’ve been on the sidelines for a while now, living in rental apartments or their in-laws’ spare bedroom. While some who lost their home to foreclosure over the past half-dozen years have decided that home ownership is not the right path to pursue, another group has been patiently waiting—and planning—for another chance.

This contingent of potential buyers has been focused on rebuilding their credit, saving up for a down payment, and watching the interest rates descend to record lows while rents creep upward.

A fall 2012 report by the Federal Reserve Bank of San Francisco found that 30 percent of borrowers who defaulted in 2001 took out another mortgage within 10 years. So even though the odds remain steep for those involved in more than 4 million foreclosures since 2007, you can expect to see more and more of such consumers reaching out for your help. It’s incumbent on you to help these potential buyers determine whether they’re truly capable of getting back in the market. Do you know where to begin?

Blanca Byrne, SFR, broker-associate at Keller Williams Premier Properties of Miami, says the No. 1 hurdle, even for those who have gotten their personal finances back on track, is access to the mortgage market. “Many of these buyers have not recuperated from long-term job loss, loss of business income, or the loss of all their savings and retirement accounts. In some cases, buyers may be ready to purchase and have the down payment money saved. They may be able to afford monthly payments. But they can’t qualify for the loan needed to make the purchase.”

That said, practitioners are finding that a foreclosure doesn’t necessarily dampen a former home owner’s enthusiasm for returning to the market. “While some rebound buyers are discouraged, many more remain eager to jump back into home ownership. They miss the mortgage interest deductions. They still think and feel like home owners and want a place to call their own—not just pay rent to a landlord,” says Aaron Lewis, CRS, associate broker and REO specialist with Prudential California Realty in Turlock, Calif.

Lewis’ clients, Richard and Rebecca Nannie, recently entered escrow after losing two homes, one to foreclosure and a second that was included in a 2009 bankruptcy.

“We made the calculated decision to put the smaller home into short sale,” Rebecca Nannie recalls. However, at the beginning of the housing crisis, “we had an offer, but after several months there was no reply from the bank. Our buyers moved on to another home, [and] we lost the only offer we had. The banks at that time were not responding to short sales. The home went into foreclosure. We then made a conscious decision to file for bankruptcy. We had a retirement to protect.”

For more than three years starting in February 2009, the Nannies rented, but they remained determined to become owners again. During this time, they became serious about rebuilding their credit, altering their lifestyle, and educating themselves.

“If this was going to be a financial lesson, we were going to learn as much as possible,” Rebecca says. With FICO scores in the 300s, they took a proactive approach, which included following the Oprah Debt Diet and Dave Ramsey’s Financial Peace University and sticking to a monthly budget. “We committed to living a no-debt lifestyle. Our standard of living had to come down for it to go back up.”

The first step in the Dave Ramsey approach required the Nannies to shun credit cards, establish a $1,000 emergency fund, and then systematically pay off debts, smallest to largest. Similarly, Oprah’s Debt Diet stresses the importance of identifying the true extent of one’s debt, and then requires the tracking of spending and steps to grow income.

Mortgage Insurance Matters

Agents across the country concur that financing is more difficult these days even for those with good credit. Byrne has been working with a couple who both have excellent credit scores (779 and 789, respectively), but who struggled to obtain mortgage insurance largely because of an error on their 2011 income tax return.

“Mortgage insurance is a requirement for buyers with less than 20 percent down,” notes Byrne. “Even if the lender believes that the borrower would be a good credit risk, they are not able to originate the loan without mortgage insurance approval. And unfortunately, the real estate crisis pushed many mortgage insurers out of business; the ones who survived, because they have fewer competitors, have become extremely picky, which means those with a foreclosure in their history will have a tough time obtaining coverage.

“This environment of fewer mortgage insurers combined with tighter restrictions on income and credit scores,” says Byrne, “means that foreclosed buyers are forced to lower their home expectations and work harder to save more for the down payment.”

But the requirements for qualifying for a loan can feel especially confusing, if not downright capricious.  “For instance, Fannie Mae says a 600 FICO score is required, but a lender may overlay its own requirement of a 640 FICO score,” Lewis said.  Lender conflicts over the effect of a “derogatory event” like a foreclosure can halt an otherwise promising transaction. “Agents may not know to check [these disparities]. It could make a difference of a year or more in the borrower’s ability to buy. The reason lending is tight is because money is tied up in REOs, foreclosures, and nonperforming loans still on the books,” Lewis adds. The rebound buyers Lewis sees are receiving FHA loans, largely because the FHA allows a 3.5 percent down payment and a waiting period of just three years after foreclosure. By contrast, Fannie Mae and Freddie Mac guidelines typically impose wait times of at least seven years to qualify for a mortgage, or three if there were extenuating circumstances such as a job loss or death of a wage earner.

Rebounding From Shame

In addition to financial hurdles, many rebound buyers must overcome feelings of deep loss and even shame. Lola Audu, broker-owner of Audu Real Estate in Grand Rapids, Mich., recently helped a long-time client named Robert come back from the devastating effects of a 2009 job loss, which led to bankruptcy and foreclosure of the home he shared with his wife. Even when he was hired back by his former employer as a machine repairman two years later, Robert had assumed that home ownership would never again be possible for them.

But eventually he reached out to Audu. With her help, Robert was able to buy a 1960s-era tri-level home. Thanks to falling home values, the home was both larger and less expensive than the one he had lost. Audu says her client was able to qualify for an FHA mortgage because he not only had gone back to work in his field but also managed to pay off debts and clean up his credit history.

Exactly three years from the day the gavel dropped on the sheriff’s sale of his old home, Robert made an offer on the new home, and it was accepted. With a $10,000 down payment, the deal closed, and Robert and his wife recently moved into their home.

Audu says real estate professionals have an obligation to help rebounding buyers understand what it takes to get back in the market. “It’s an arduous, step-by-step process, helping a client negotiate the labyrinth involved in qualifying for another loan,” she says. “We should be providing these would-be buyers with hope and encouragement.”

Meanwhile, the Nannies were diligently rebuilding their credit. “We knew that it would take two years for the bankruptcy to be discharged, but we found out that the FHA required a three-year probationary period after foreclosure to buy again,” says Rebecca Nannie. To prepare for the day they could return to the market, they talked to a lender, kept paying 
down their debts, saved money, and watched the market. “We saw the inventory was shrinking,” says Rebecca Nannie. “We went to a lender on a Friday and were approved. We visited our agent the following Monday.”

The Nannies, who expect to pay PMI for five years, took possession of their new home Dec. 31 and moved in late January after the kitchen and flooring were upgraded. “Very few people understand the market, because there is not a lot of education out there about restoring credit and credit healing … and credit does heal,” she adds. As the Nannies’ experience shows, working with rebounding buyers is a long-term proposition. “At some point, they will be ready to buy,” says Byrne, “and they will certainly have a huge degree of loyalty to the agent who stuck with them through the hard times.”

Waiting Periods

Prospective buyers who’ve experienced a foreclosure or bankruptcy can 
expect the following waiting periods before they can seek loan approval.

  Fannie Mae and Freddie Mac Dept. of Veterans Affairs Federal Housing Administration
Foreclosure Seven years, but the lender will make exceptions at three years if extenuating circumstances are met such as job loss or death of a wage earner. Generally, not less than two years with foreclosures and bankruptcies filed under straight liquidation and discharge provisions. If the foreclosure was on a VA loan, the buyer must have paid the VA for its loss before qualifying for a new VA loan. Three years, but the FHA may grant an exception if the foreclosure was a result of serious illness or death of a wage earner and the borrower has reestablished good credit.
Chapter 7 or 11 Bankruptcy Four years (two years with extenuating circumstances). Under a Chapter 7, two years after the discharge with reestablished good credit or no incurred new credit obligations,
Chapter 13 Bankruptcy Two years from discharge date; four years from dismissal date. After making 12 months of payments to a court-appointed trustee and the trustee or the bankruptcy judge approves new credit. One year current on required payments to be considered.

Beaty Reynolds is a freelance writer for REALTOR® Magazine.

Paula Hess

Paula Hess is a freelance writer for REALTOR® Magazine.