The Recovery Period – After a Short Sale

To any person who has ever taken out a mortgage, the mere mention of the phrase ‘short sale’ is enough to cause a small shudder. A short sale is something no borrower ever wants to find themselves having to consider. Ideally, when a borrower sells their home, they sell it for everything they still owe on the home and some extra. This is possible even if they sell the home for the same amount they bought it for because they’ve been making payments on the home since they took out the mortgage. Any extra amount beyond what they still owe on the home goes into their pocket (new car, anyone?) A short sale is the exact opposite of this situation, where the borrower ends up in a situation in which they end up selling the house for less than they owe on it (sometimes significantly less). Rather than having extra  money in their pocket after the sale, they still have a large bill to pay in addition to whatever rent or mortgage they’re now paying on their new residence. Since that bill can be tens of thousands of dollars, a short sale is a shudder-worthy phrase.

The nice thing for VA loan borrowers is that a short sale is exactly the type of situation that makes having a VA guarantee so valuable that lenders will give you a better interest rate because of it. The VA loan version of a short sale is called a VA compromise sale, and consists of the VA making up the difference between the amount that the home sells for and the amount still owed on the home. Don’t get any ideas, though, because this still leaves the borrower with nothing extra in their pockets at the end of the transaction. In addition, after a short sale or compromise sale, your ability to get approved for a good mortgage drops significantly for quite some time. While a short sale doesn’t follow you for as long as a foreclosure, it still is pretty devastating to your credit. Short sales are often the final resort to avoid a foreclosure.

So what about after a short sale? Is there a waiting period before a borrower can be eligible to apply for a new VA loan? Indeed there is. The VA requires a two-year waiting period before a borrower that made a short sale can be eligible to apply for a new VA loan. This is assuming the delinquent amount has been paid off, but if it hasn’t, things get stickier, and it’s different if it was a short sale on a conventional loan or a compromise sale on a VA loan. Essentially, after two years, the VA will allow you to apply for a VA loan regardless, but on a short sale, if the amount hasn’t been paid off, it’s up to the lender to approve or disapprove a new loan. In the case of a VA compromise sale, where the VA paid money to a lender on behalf of the delinquent borrower, the VA will only guarantee the amount the borrower originally qualified for less the amount the VA paid on their behalf. In other words, if a borrower originally qualified for up to $400,000, and the VA had to make up $50,000 of their last mortgage, the borrower may only qualify for up to $350,000. The borrower can pay the VA back the money to restore the entitlement, but it usually doesn’t save the borrower enough money in the long run to justify the expense.

So when a lender is considering approving a new VA home loan for a borrower who still hasn’t paid off the difference from the short sale, they will usually have certain conditions that have to be met in order to approve it. Almost universally, the borrower would have had to maintain excellent credit after the short sale. The lender may require additional employment and income verification, and written documentation of the circumstances surrounding the short sale. Many lenders do not approve borrowers who still owe money on short sales even after the two year waiting period. Those lenders that do approve borrowers will certainly not offer the most advantageous interest rates. For this and many other reasons, it is essential that any person taking out a mortgage on a new home does everything in their power to meticulously plan for the next 15 or so years to minimize the risk that they will be forced into a short sale. Have enough in savings that you could make your mortgage payment for 6 months if you lost your job, keep improving your education so you can get a new job quickly if that happens. Know what your options are if money begins to get tight, and don’t get a mortgage that’s going to cost more than you can reasonably afford to pay.

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*Annual savings calculator based on 2015 monthly average savings extrapolated year-to-date.