If you give up your current home, how soon can you buy another one? With millions U.S. homeowners "underwater" on their mortgages or even facing foreclosure, it's a question that many are pondering.
It's a particularly relevant question for homeowners who may be considering a "voluntary foreclosure;" that is, to simply stop paying the mortgage and give up the home because they owe more than it's worth. From their perspective, to continue paying a $400,000 mortgage on a home that's now only worth $250,000, for example, is simply to throw good money after bad.
In fact, it's an approach that's even being endorsed by some experts. University of Arizona law professor Brent White argues that so-called "strategic defaults" can potentially save homeowners hundreds of thousands of dollars and are morally no different from a business deciding to cut its losses on a venture.
But regardless of whether a foreclosure is voluntary or not, you still need a place to live. And while being a renter is always a possibility, many will still want to return to home ownership eventually, particularly those who gave up their previous homes as an economic choice, rather than out of necessity.
Five-year wait for Fannie, Freddie mortgages
If you lose your home to foreclosure, voluntary or otherwise, you won't be able to qualify for a Fannie Mae or Freddie Mac conforming loan for at least five years and perhaps seven. Same for an FHA loan. Because conforming and FHA mortgages account for the great majority of home loans made in this country, particularly in the middle and lower price ranges, that's a pretty big obstacle to overcome.
Of course, you can always seek a nonconforming mortgage, but those lenders will have their own guidelines for how soon they'll lend after a foreclosure. They'll also be likely to demand a hefty down payment and charge a relatively high interest rate.
This is one reason why a short sale or deed-in-lieu of foreclosure may be better strategies than simply allowing your home to go into foreclosure. With a short sale, you can qualify for a Fannie Mae/Freddie Mac-backed mortgage in as little as two years, and three years on a deed-in-lieu. And while both have the same impact on your credit rating as a foreclosure, your credit can begin to recover in as little as two years after any of them. That's according to the Fair Isaac Corporation, which developed the FICO credit scoring system used by the three major credit rating agencies.
Credit impacts decline after two years
That's not to say you'll get a great interest rate after two years, but you can at least get a decent one. Of course, the full effect of a foreclosure, short sale or deed-in-lieu will remain on your credit for seven years, but the impact does begin to tail off significantly after the first two.
As for the effect on your credit score of a foreclosure or short sale, many mortgage advisers say you can expect a drop of 200-300 points, with the biggest drop for those whose credit was previously unblemished. However, much of that decline is due to the accumulation of missed or late payments that precede a foreclosure or late score. Examples provided by Fair Isaac Corp. put the impact of a foreclosure or short sale by themselves at about 100-150 points.
In sum, if you're faced with the possibility of losing your own, either involuntarily or as a deliberate economic choice, you're probably better off pursuing a short sale or deed-in-lieu instead of simply allowing the property to fall into foreclosure. The effect on your credit score may be the same, but if you want to get back into home ownership within a relatively short time, either a short sale or deed-in-lieu will provide the quicker route back, provided your lender is agreeable to them.