Can I Get a Mortgage With a Short Sale on My Credit?

A short sale occurs when a homeowner sells their property for less than the amount they owe on their mortgage, with the lender’s approval. This process often takes place when a homeowner faces financial difficulty and seeks to avoid a foreclosure. While a short sale can provide an alternative to foreclosure, it does impact an individual’s credit history and can affect their ability to obtain future financing. This article explores the implications of a short sale on mortgage eligibility and outlines steps to navigate the path toward future homeownership.

Impact on Mortgage Eligibility

A short sale affects a credit report, appearing as “settled for less than the full amount” or a similar notation. This can reduce credit scores by 50 to 150 points, depending on the borrower’s credit history. The record remains on a credit report for up to seven years, though its influence diminishes over time.

The ability to secure a new mortgage after a short sale depends significantly on the type of loan program sought, as each has specific waiting periods.

Conventional Loans

For Conventional loans, backed by Fannie Mae and Freddie Mac, the typical waiting period is four years from the completion date of the short sale. However, this period can be reduced to two years if the borrower can demonstrate extenuating circumstances, such as job loss or a severe illness, which led to the short sale.

FHA Loans

FHA loans, insured by the Federal Housing Administration, require a three-year waiting period after a short sale. This period might be shortened if the borrower maintained timely payments on their previous mortgage for 12 months before the short sale and continued to pay all other installment debts on time.

VA Loans

For VA loans, guaranteed by the Department of Veterans Affairs, the waiting period is typically two years from the short sale completion date. However, there may be no waiting period at all if the borrower was current on their mortgage payments for the 12 months preceding the short sale. This flexibility often depends on the specific lender’s policies.

USDA Loans

USDA loans, offered through the U.S. Department of Agriculture, have a three-year waiting period following a short sale. Limited exceptions for shorter waiting periods may exist, but demonstrating financial stability and credit re-establishment remains important.

Lender Considerations Beyond the Short Sale

Beyond the waiting period associated with a short sale, lenders evaluate several other factors to determine mortgage eligibility.

Credit Score

A strong credit score is required, with minimums ranging from 620 to 680 or higher, depending on the loan program and lender guidelines. While a short sale impacts credit scores, demonstrating responsible credit management during the waiting period is important for qualifying.

Debt-to-Income Ratio

The debt-to-income (DTI) ratio is another important metric lenders assess. This ratio compares a borrower’s total monthly debt payments, including the prospective housing expense, to their gross monthly income. Lenders prefer DTI ratios below 36%, though some programs, like FHA loans, may allow for higher ratios, up to 43% or even 50%, especially with compensating factors like significant cash reserves.

Employment History and Income

Lenders examine a borrower’s employment history for stability. They prefer a consistent work record, looking for at least two years in the same line of work or industry. Gaps in employment or frequent job changes may require additional explanation or documentation. Verifiable income is essential, with lenders requiring proof through recent pay stubs, W-2 forms from the past two years, and tax returns. Self-employed individuals often need to provide more extensive documentation, such as two years of tax returns and profit and loss statements, to verify their income stability.

Assets and Reserves

Available assets play a role in the approval process. Lenders assess funds for a down payment, which can range from 3% to 20% or more of the home’s purchase price depending on the loan type.

Beyond the down payment, lenders may require borrowers to have financial reserves, which are funds remaining after closing, equivalent to two to six months of mortgage payments. These funds must be “seasoned,” meaning they have been in the borrower’s account for a specified period, and their source must be verifiable.

Strengthening Your Mortgage Application

Taking proactive steps to improve your financial profile after a short sale can significantly strengthen a future mortgage application.

Rebuilding Credit

Rebuilding credit is a key part of this process. It involves consistently making all payments on time, as payment history is a primary factor in credit scoring. Maintaining low credit card balances, below 30% of available credit, also helps improve credit utilization.

Avoid opening new credit accounts unnecessarily, as multiple credit inquiries can temporarily lower scores. Regularly checking credit reports from all three major bureaus—Equifax, Experian, and TransUnion—for accuracy and disputing any errors is important. For those with limited credit, responsibly using secured credit cards or small installment loans can help establish a positive payment history.

Improving Debt-to-Income Ratio

Improving the debt-to-income ratio is a key step. This can be achieved by paying down existing debts, such as credit cards, auto loans, and student loans. Avoiding new debt obligations during the preparation phase is beneficial. While increasing income can also lower the DTI ratio, reducing existing debt is a more direct strategy.

Saving for Down Payment and Reserves

Saving for a down payment and establishing financial reserves are key components of a strong application. Creating a dedicated savings plan and consistently contributing to it helps build the necessary funds. Understanding that down payment funds are distinct from closing costs, which range from 2% to 5% of the loan amount, is important for accurate financial planning.

All funds intended for a down payment and reserves should be “seasoned” in a bank account, meaning they have been held for a period, 60 to 90 days, to verify their source and stability.

Gathering Documentation

Gathering all necessary financial documentation in advance is a practical step. This includes W-2 forms and pay stubs, two years of tax returns, bank and investment statements, and all documentation related to the short sale, such as the approval letter and completion records.

The Mortgage Application Journey

Once preparatory steps are complete, the mortgage application journey begins with finding a suitable lender.

Borrowers can explore options from various financial institutions, including traditional banks, credit unions, and mortgage brokers. Shop around and compare rates, terms, and lender programs, particularly seeking those with experience assisting borrowers who have experienced a short sale.

Mortgage Pre-Approval

An early step is obtaining mortgage pre-approval. Unlike a basic pre-qualification, pre-approval involves a thorough review of a borrower’s credit, income, and assets by the lender. This process provides a clear understanding of the maximum loan amount a borrower qualifies for, setting realistic expectations and demonstrating seriousness to real estate sellers.

Formal Application and Underwriting

After a property is identified and an offer is accepted, the formal mortgage application is submitted. This stage requires the submission of all previously gathered financial documents for a comprehensive review. Providing accurate and complete information at this point helps to prevent delays and ensures a smoother process through subsequent stages.

The underwriting process follows, where a mortgage underwriter evaluates the application to assess the risk involved for the lender. Underwriters examine a borrower’s credit history, income stability, assets, and the property itself. They may request additional documentation or explanations to clarify any aspects of the financial profile, focusing on the “three C’s”: credit, capacity, and collateral.

Appraisal and Inspection

Following the underwriting review, an appraisal of the property is conducted to determine its market value, assuring the lender that the loan amount is justified by the property’s worth. A home inspection identifies any structural or mechanical issues with the property. Both the appraisal and a satisfactory inspection are required before final loan approval.

Loan Approval and Closing

The final stage is receiving loan approval and proceeding to closing. Once all conditions are met, the lender issues a “clear to close” notification. At closing, the borrower signs all legal documents, and funds are transferred.

Borrowers receive a Closing Disclosure (CD) at least three business days before closing, detailing the final loan terms, projected monthly payments, and all associated closing costs. Reviewing this document carefully and comparing it to the initial Loan Estimate is important to ensure accuracy before signing.