Getting a VA Loan After a Financial Setback
Bankruptcies, foreclosures and short sales don’t prevent military veterans ever again taking advantage of their VA home loan benefit. With the passage of time and more financially responsible behavior, veterans are able to get right back into home ownership with a VA-guaranteed home loan.
Let’s face it; no one is immune to financial setbacks. It’s pretty easy to get in over one’s head and suffer a financial misfortune. Especially in slower economic cycles. The following article explains the particulars for getting a VA loan after three common financial situations:
- Short sale
Let’s dive right in and get a better understanding of how things work.
VA Loan After Bankruptcy
Chapter 7 and Chapter 13 bankruptcies are treated a differently in terms of VA loan guidelines. Each type of individual bankruptcy has a different set of conditions that must be met before veterans are re-eligible. Here are the particulars.
VA Loan After Chapter 7
Chapter 7 bankruptcies completely discharge a debtor’s obligations. There is no repayment plan. Trustees are assigned to the bankruptcy case and sell off of the debtor’s eligible property. The proceeds from those sales go back to the creditors.
Chapter 7 is the more severe type of individual bankruptcy. Fair Isaac Corporation, developer of the FICO score, says bankruptcies can shrink a person’s credit score by 130 to 240 points.
Key points about VA loans after Chapter 7:
- It is reported for 10 years because none of the debt is repaid by the debtor.
- VA requires 2 years since discharge before borrowers are eligible for a new VA loan.
- Just for the sake of comparison, conventional loans typically require 4 years after Chapter 7 bankruptcy.
Borrowers still need to put effort into maintaining or improving their credit score. We’ll touch on that more below.
VA Loan After Chapter 13
Chapter 13 bankruptcies consolidate and restructure a debtor’s obligations. Debts are not erased. Instead, a debtor repays them over time. A trustee collects monthly payments and then pays the creditor(s). Because the debtor is ultimately making good on his or her obligations, there’s no required sale of assets.
Since at least some of the debt is repaid by the borrower in Chapter 13 bankruptcy, it considered a less severe bankruptcy.
While less severe, a Chapter 13 (like Chapter 7 above) will still shave 130 to 240 points off of a borrower’s credit score. However, some of the conditions below are more lenient.
Key points about VA loans after Chapter 13:
- Chapter 13 BKs are reported on a credit file for 7 years from the filing date.
- VA only requires 1 year to pass since bankruptcy discharge.
- Again, VA rules are more lenient than conventional loans which typically require 4 years after Chapter 13 bankruptcy.
While the VA only requires one year of waiting to be eligible again, borrowers should be sure to have no late payments over a 12-month payment history. This is the time to be very diligent about one’s finances.
VA Loan After Foreclosure
A foreclosure is when a lender (e.g. a bank, credit union or mortgage company) takes possession of a home because the borrower is delinquent on mortgage payments. In most cases, the homes are already abandoned. In cases when there are still occupants, they will be evicted. The party is over.
The lender then puts the wheels in motion to sell off the home. Foreclosure transactions happen relatively quickly as lenders are motivated to liquidate the asset and recoup as much value as possible. They really don’t want to hold onto and manage properties; it’s not their area of business interest nor expertise. They don’t want to be a landlord.
Borrowers can expect to take a hit of 58 to 160 points to their FICO score for a foreclosure.
Key points about VA loans after foreclosure:
- Foreclosures show up on a credit report for 7 years.
- The waiting period to apply for a new VA loan is 2 years from the time of the foreclosure or deed in lieu.
- It’s the same even if the foreclosed property was originally financed using a VA loan.
- By way of comparison, conventional loans require borrowers to be 7 years removed from foreclosure.
VA Loan After Short Sale
A short sale is a real estate transaction where a property is sold for less than its mortgage loan amount. In the short sale scenario, the lender does not take possession nor put the home up for sale. The sale of the property falls on the borrower.
For example, a distressed borrower could be behind on mortgage payments (or can no longer make them) and needs to sell their home. Imagine their home worth $250,000 and carries a mortgage of $260,000. Uh oh. That means the home is $10,000 underwater.
With approval from their lender, the borrower may sell the home for less than the mortgage amount. But the borrower must first negotiate the price with any potential buyers and then negotiate with the lender. Lenders have the final say.
Sometimes short sales take considerably longer to close than foreclosures. There’s more paperwork, too. Lenders do quite a bit of due diligence to make sure they are not getting ripped off. They will be very careful about the appraisal to make sure fair market value is accurately determined.
Fair Isaac indicates that a person’s FICO score could drop by 85 to 160 after a short sale.
Key points about VA loans after short sales:
- Some lenders allow borrowers to a purchase a home using a VA loan immediately after a short sale.
- For comparison, conventional loans require 4 years to pass from the time of a short sale.
Much can be done intervening period (12 to 24 months) between bankruptcy or foreclosure and taking out a new VA loan. This is the time to be financially responsible and shore up one’s credit profile and score.
Credit Scoring Model
There are five contributing factors when determining a FICO score. Each category is weighted to give it a different degree of importance when computing an individual’s credit score. Here are the categories:
- 35% Payment History – it’s best if borrowers pay bills on time and in full.
- 30% Amounts Owed – it’s not ideal for folks to be overextended or maxed out.
- 15% Length of Credit History – longer amounts of time for each credit account is best.
- 10% Credit Mix – responsible use of several types of credit such as credit cards, retail accounts, loans, etc. is best.
- 10% New Credit – opening several accounts in a short period of time is risky (don’t even think about it).
Furthermore, weight can be placed on other borrower attributes. For example, borrowers with a longer credit histories tend to get a better score than borrowers with shorter credit histories.
If your FICO took big hit from a bankruptcy, foreclosure or short sale, you might find yourself needing to climb back up to a 620 credit score. 620 is the minimum FICO score for VA home loan eligibility.
But there’s a bonus for building an even higher one. Borrowers with higher credit scores typically get lower interest rates when they buy or refinance a home. Yep, there is a direct relationship between good credit scores and good loan terms.
Here’s how to repair your credit in preparation for a VA loan application.
- Pay every bill that is due.
- Make payments in full.
- Make payments on time.
- Pay down debts and don’t take one any new debt.
- Keep credit balances low and by all means, don’t max out.
- Set up payment reminders.
Delinquencies are really, really damaging to credit scores and should be avoided at all costs. What’s more, they tend to do more damage to people with lower initial credit scores than folks with higher initial scores. Here’s a look at the kinds of hits that late payments and other financial setbacks make on two different types of borrowers.
You will be well-served during a credit rebuilding period to know your credit score and monitor it. Access to one’s financial history and credit score has never been easier. Plus, federal law mandates that you can get a free copy of your credit report once per year. Check out AnnualCreditReport.com. Some folks eventually decide to pay a fee for more frequent credit monitoring. But you only need to get started with a free version.
Checking your score will give you a benchmark so that you can see how much improvement you are making as you get better at managing your finances. Watching scores improve provides motivation to continue. And there’s a real sense of satisfaction.
In addition to improving one’s FICO score, folks will want to be mindful of their length of employment. If possible, keep a job with your current employer for 2 years or more. Doing so helps your case as it the best case scenario according to VA loan guidelines.
VA Loan Application
When you’re ready to get back in the game and apply for a VA loan, the VA loan process is exactly the same as your first home buying experience. The following steps should look familiar:
- Get your Certificate of Eligibility (COE) from VA
- Get pre-qualified with a lender
- Shop for a home with a Realtor
- Make an offer
- Property inspection (not required but highly recommended)
VA Lender Overlays
VA guidelines set the minimum requirements for lenders, borrowers and properties. All the rules they make must be met in order for the loan to receive the VA Guarantee. Sometimes lenders set their own underwriting guidelines over and above those VA rules. These are called lender overlays. Overlays are not ridiculously wild or extra tough on borrowers. Just be aware that they exist. Sometimes it’s just a difference of maybe 20 points on a credit score.
Whether a veteran has been through bankruptcy, foreclosure or a short sale, there’s always a second chance. VA-guaranteed loans are made all the time to folks who’ve been through financial difficulties. Knowing and understanding the VA guidelines above is important. Knowing what the heck you need to do to improve your credit is also key. These roadmaps set the foundation for you to actually achieve it. Time and financial responsibility are the two ingredients that can help anyone be a homeowner again.