Short sales are not new. However, the recent housing and financial crisis resulted in more short sales than ever before in U.S. history.
During the recent housing crisis, a huge number of homeowners across the U.S. have suffered from negative equity, where housing prices plummeted and the mortgage owed was greater than the worth of the home. “Short sale” is the process where the lender works with the homeowner to “accept a balance less than the full amount” for negative equity owed when the homeowner cannot come up with the balance to pay off the difference. “Underwater” is a common term to describe the negative equity position.
Lender/Investor/Servicing Policy Requires Delinquency
It is often unclear if it is the investor, lender or servicer that requires a delinquency in order to approve for a short sale. However, this is a common requirement, given verbally upon learning how to proceed with a short sale.
Required timeframe of delinquency varies per lender. However, the lengthy short sale processing timeframe that requires the delinquency throughout often exceeds 120 days. After a mortgage delinquency passes 120 days, credit code is commonly coded as a foreclosure.
Though there are two credit variations provided through the Metro 2 format in the Experian Glossary for a short sale, lenders often apply this code with additional foreclosure code also borrowed from the Metro 2 format. Payment history coding that is “8” or “9” can also cause short sale code to produce a foreclosure code instead.
There is no specific, universal short sale credit code used by all lenders. Phone calls to representatives at many lending institutions trying to help those affected with an erroneous foreclosure code on short sale credit result in frustration for both the lender and the affected consumer. Lenders state they have coded the short sale credit correctly with the available code given to them.
However, when it was learned that the CFPB Complaint Letter and the Lender Letter would most often result in a code changed, it was clear that lenders have the ability to change coding, or these corrections could not have been made.
Mortgage Delinquency Over 120 days Results in Foreclosure Code on Short Sale Credit!
- Lenders trying to streamline the short sale process practiced “dual tracking”, where the underwater homeowner would be on a loss mitigation track while simultaneously being processed for a foreclosure, in case the short sale approval was not obtained. However, to start this “dual track”, lenders require mortgage delinquency for a short sale. The short sale approval process is commonly over 120 days. Once the mortgage is over 120 days late, mortgage credit is coded as a foreclosure.
- It was learned that the short sale codes being used were borrowed foreclosure code from the Metro 2 system. It was soon realized that there was no specific code for a short sale, and delinquent payment history coupled with the code ultimately resulted in the foreclosure code on credit.
- The harm to mortgage credit was only learned after being seen in both Fannie Mae and Freddie Mac automated underwriting systems. Still unclear is the impact that the erroneous foreclosure code may also have on other credit of affected short sellers.
WHY is Foreclosure Code So Harmful? It Requires 7 YR wait to get a New Conventional Mortgagee, Rather than 2 YR wait After a Short Sale!
- The wait timeframe after a foreclosure is seven years for a new conventional mortgage.
- The wait timeframe after a short sale is two years (with 20% downpayment) or four years (with 10% downpayment.)
- This problem only affected new conventional mortgages. FHA and VA have a separate automated system that works alongside the Fannie Mae Desktop Underwriter/Originator and the Freddie Mac Loan Prospector called Total Scorecard. Total Scorecard acknowledges the past mortgage, but does not provide a new mortgage denial and requires that the lender underwriter determine the correct case for that past mortgage.
- Both Fannie Mae and Freddie Mac automated systems for a conventional mortgage read the credit code as a foreclosure and denied the new mortgage.
- Only manual underwriting, where lender underwriters would approve the loan without an automated approval, could be done to overcome the problem. No lenders were being found within the U.S. mortgage markets that would manually underwrite these conventional mortgages.
- New non-Qualified Mortgages (QM) were sprouting up that would allow financing, but only at higher interest rates. This caused many past short sellers across the U.S. to come forward about this problem. Written mortgage guidelines clearly defined criteria where past short sellers could re-apply for a mortgage again. Yet, that criteria was not working.
- Initially, conventional mortgages had the shortest wait timeframe to re-enter the housing market: 2 years with 20% downpayment or 4 years with 10% downpayment.