Need to finance a home this year? If you had a previous short sale, pay very close attention to your credit report, because it might list the home as a foreclosure. It’s important to know how this difference can prevent you from getting a new mortgage again, and how you can deal with it so you can get a mortgage.
Maybe you’re purchasing another home to live in, or for investment property. Perhaps you’re financing your primary home for a specific purpose. Whatever the reason, the credit reporting from the previous shorted lender can make or break your new mortgage.
Short-selling allows homeowners to avoid foreclosure. Foreclosure involves defaulting on the mortgage, and essentially giving the house back to the bank, and is typically seen as the worse event of the two, in terms of credit-worthiness.
Lenders are obligated to report the true and exact circumstances surrounding a delinquency. When reporting on a short sale, they will typically report “Settled for less than full balance.” This is what the new lender you’re working with on your loan will want to see because this indicates the previous property was a short sale.
However, while lenders do have a responsibility to report accurately to the credit bureaus, it doesn’t mean they always do. It’s not uncommon to see a previous lender reporting the property as “Settled for less than full balance, chapter 9.”
Enter a red flag…
The Credit Report Codes You Need to Watch Out For
If the previous lender includes the following codes on your credit report, you’ll need to put the brakes on your new mortgage loan process: Chapter 5, 8 or 9.
These classifications are synonymous with a foreclosure, which can deter your ability from successfully procuring a mortgage two years after a short sale.
For a short sale, a borrower is eligible for conventional loan financing 24 months post-short sale at 80% loan-to-value or lower.
But for a foreclosure, a three-year window is required to get a mortgage again with as little as 3.5% down on a primary home with an FHA loan. Seven years must have passed for the homebuyer to qualify for a conventional loan post-foreclosure (or, four years with extenuating one-time economic hardship circumstances).
So the addition of chapter 5, 8 or 9 flags the previous short sale on the credit report as a foreclosure, thereby making the loan ineligible for conventional financing in a shorter time frame.
How to Challenge the Code
All mortgage companies originating run each and every loan through what’s called an automated underwriting system (AUS), sort of like Google for mortgage lenders, but it evaluates the credit, debt, income and assets — the total borrower picture — and gives a preliminary approval. The chapter 5, 8, or 9 prevents the AUS from issuing the preliminary approval.
Here’s what you can do to challenge the item:
- Write to the creditor.
- Include a copy of the final settlement statement indicating the previous property you owned was a short sale, as well as a copy of the grant deed transferring the property from you to the buyer.
- Explain to the creditor that there is an erroneous item (the chapter 5, 8, or 9) on your credit report, and that it must be removed to indicate a short sale.
- Wait about 60 days to receive the confirmation letter.
- Re-apply for the new mortgage.
Because there were so many short sales processed in recent years – and this is especially true with the bigger banks – lenders’ credit reporting may not have been as accurate as it could have been. So this is exactly why it’s especially important to check your credit reports before you apply for a mortgage. (You can do this for free once a year from each of the three major credit reporting agencies.) If you find these foreclosure codes listed on your short sale before you apply for a mortgage, you’ll know that you need to clear up the error first in order to put yourself on the path to a new mortgage.
[Editor's Note: If you're working on rebuilding your credit after a short sale, monitoring your credit scores can be a great way of tracking your progress. You can do this for free using the Credit Report Card, which updates two of your credit scores for free every month.]
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