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Americans Seize Second Chance Mortgages Post-Foreclosure

By Prashant Gopal
April 03, 2013 9:33 AM EDT 51 Comments
A worker during construction of a house in Rancho Santa Fe, California.
Photographer: Sam Hodgson/Bloomberg
A worker during construction of a house in Rancho Santa Fe, California.

Jason Schmitt lost his $90,000-a- year job at an oil rig in 2009. The bank repossessed his Tulsa, Oklahoma home and the former Army combat engineer went bankrupt. Last month, after moving with his family to his Missouri hometown, he got a Veterans Administration mortgage that lets borrowers buy property just two years after a foreclosure.

“I’m not embarrassed by saying we had a bankruptcy -- it seems that so many people have fallen victim to losing their job,” said Schmitt, 35, now a recruiter for the Department of Veterans Affairs. “We’ve come back from this and we are not going to give up on homeownership.”

The Schmitts are at the vanguard of potential buyers that were locked out of owning homes after 15 percent of U.S. borrowers lost their properties since the start of the foreclosure crisis. Even as banks are holding borrowers to stricter mortgage standards, the improving job market is lifting incomes and helping families repair credit scores, expanding the pool of eligible buyers and providing additional firepower to the housing recovery.

About 7 million mortgage holders have had to leave their homes since 2007 because of foreclosure or a short sale, in which a property is sold for less than is owed, according to RealtyTrac. More than 1 million of them are now eligible for mortgages backed by the Federal Housing Administration, which requires a three-year waiting period and a minimum 3.5 percent down payment, said Mark Zandi, chief economist for Moody’s Analytics Inc. in Westchester, Pennsylvania.

Eligible Expanding

While many Americans will be blocked from buying because of insufficient credit, savings and income, eligible households will expand to nearly 2 million by the end of 2014, he said.

“This could be a significant source of housing demand going forward,” said Zandi. “Lots of people lost jobs through no fault of their own. They will be good credit risks in a reasonably good economy. It was not their willingness that was the problem, but their broad ability to pay.”

As the economy has recovered from the longest recession since the Great Depression, Americans have lifted their credit scores by paying off credit cards, car loans and other debts, said Joanne Gaskin, product management director for scores at FICO, which measures on a scale that ranges from 300 to 850 and is crucial in determining access to credit.

More mortgage borrowers have scores of 800 or more than two years ago and a greater number of them are rising in the 560 to 660 range, she said. The median score climbed from 711 in October 2011 to 714 a year later.

Shrinking Supply

As more buyers are able to access credit, competition for a shrinking supply of homes is driving up prices. The inventory of homes for sale rose in February after dipping to a 12-year low in the previous month.

Rising home values are also helping homeowners regain equity, allowing more of them to refinance and providing an incentive to stay current. Prices rose 10.2 percent in the 12 months through February, the biggest increase in seven years, according to Irvine, California-based CoreLogic Inc. More than 1.7 million homeowners returned to positive equity in 2012 and seriously delinquent mortgages fell to the lowest level since 2008, the Mortgage Bankers Association said on Feb. 21.

“The upward shift in FICO scores is good news for the housing and mortgage market as there is a significant percentage of the U.S. population that would be considered good quality borrowers for consideration,” Gaskin said.

Easing Underwriting

While underwriting standards remain restrictive compared to the real-estate boom, they’re easing as lenders approve loans for borrowers with lower credit scores. The average FICO score for conventional home purchase loans fell to 761 in February from 764 a year earlier, said Pleasanton, California-based Ellie Mae. Average down payments declined to 20 percent from 22 percent, according to the company, which provides software to the mortgage industry.

Lenders may further loosen standards when a wave of borrowers refinancing recedes and originators turn their focus to homebuyers, said Andrew Davidson, president of Andrew Davidson & Co, a New York-based consulting firm. The recession hit many people who would be reliable borrowers in a better economy, he said.

“If somebody bought a home and then lost a job and the home fell in value and now they have a new job and want to borrow responsibly, they are good borrowers,” Davidson said.

Jason Schmitt was fired from Baker Hughes Inc. (BHI) in 2009 after a drop in oil prices and consumer spending forced the oilfield-services provider to cull more than 3,000 positions. By October the unemployment rate in the U.S. had risen to 10 percent, up from 4.4 percent in October 2006 before the housing crash.

Rebuilding Credit

After failing to get any offers for their home and a second investment property, the Schmitts let both houses to go into foreclosure and they filed for bankruptcy. When the Department of Veterans Affairs hired him for $25,000 a year in Missouri in August 2009, he moved back with his wife, Megan, and two young children to Moberly, where he grew up before joining the Army and serving in Kuwait and Bosnia.

To rebuild his credit, the Schmitts kept to a budget, planned meals a week in advance and gave up eating out. They got a $500 line of credit from their bank and made minimum payments for a year. Everything was paid on time, from utility bills to car payments and Schmitt’s FICO score climbed to 693 after bottoming in the low 500s a few years ago. He was promoted in February and his salary rose to $58,000 a year.

Clean Slate

“We started with a clean slate,” said Schmitt, who bought a $75,000 three-bedroom property they had been renting with a mortgage from Veterans United Home Loans, a company that also provided him with free credit counseling. “This is the American dream -- who doesn’t want to own a home?” he said. “We want to plant our roots. We want our kids to be able to say, ’that’s where I grew up. And that’s my room.’”

Buyers such as the Schmitts who rebounded from a foreclosure or short sale made about 6 percent of the $3.3 billion loans Veterans United completed last year, the company said.

Jon Maddux co-founded AfterForeclosure.com late last year to find loans for borrowers who have had homes repossessed. Maddux said he’s hearing from clients of another company he helped create in 2008 called YouWalkAway.com, which advises so- called strategic defaulters who choose to walk away from mortgages they can afford because of declining home values. Maddux said he’s tapping a market that many loan officers don’t want to bother with because it’s time consuming.

Dirty Fingernails

“You have to get your fingernails dirty,” he said. “If there’s an error on a report, you have to fix that and it takes time.”

Glitches in the system are preventing more borrowers from returning to the market. Fannie Mae’s automated underwriting system is rejecting many people who should be able to qualify in as little as two years after a short sale, said Terry Clemans, executive director of the Chicago-based National Consumer Reporting Association, whose members prepare credit reports used by lenders.

Because the credit industry doesn’t have a specific code for a short sale, lenders are forced to report them as foreclosures, which delays borrowers from getting Fannie Mae and Freddie Mac mortgages, Clemans said. A foreclosure disqualifies buyers from buying with a Fannie Mae or Freddie Mac loan for up to 7 years.

Fannie Mae on March 12 acknowledged that the automated system can’t always accurately identify short sales because of the coding issue and said lenders have the option of manually underwriting the loans.

Short Sales

“It’s a very serious issue because the difference between getting into a home after a short sale and getting into a home after an actual foreclosure is twice as long,” Clemans said in a telephone interview. “The system needs to be altered so that we document short sales appropriately.”

George Albright, a 44-year-old videographer in New Port Richey, Florida with a 720 credit score and a 20 percent down payment, has been blocked by the underwriting systems of Fannie Mae and Freddie Mac, according to his mortgage broker, Pam Marron. Albright said he stopped making payments on his house in 2009 as his marriage was ending and his freelance work was slowing. Now he said he can afford to buy the townhouse that he rents for $1,500 a month because a work contract boosted his income last year to twice what it was in any of the previous nine years.

Lender Mistakes

“I bit off more than I could chew -- it was my fault and I take full responsibility for it,” Albright said. But lenders “made bigger mistakes on a grander scale and people like me are not getting a second chance. They’re like, ‘We made a mistake and are all stabilized now but we are not giving out loans.’”

Such delays can be costly for these borrowers, who see a window of opportunity closing, said Kory Kavanewsky, branch manager for CMG Financial in Coronado, California. About 10 percent of his clients who applied for home purchase loans last year had short sales or foreclosures in their past.

“They are eager and anxious about getting back into the market,” Kavanewsky said. “Even if rates go up 2 percent and sales prices go up 10 percent, it can make it so they can’t qualify.”

Some borrowers who don’t qualify for conventional financing are turning to private money lenders such as Rick Piette, owner of Las Vegas-based Premier Mortgage Lending, which gets funding from individuals and institutional investors. Piette says he spends about $15,000 a month on advertising his “second chance” mortgages in the Las Vegas market and has given out about 200 of them since June 2011.

Grown People

The mortgages, which are given to borrowers with stable jobs and at least 20 percent to put down, have an 8.99 percent rate for a 30-year term and 6.99 percent for 15 years. Among his customers is a retired couple who are closing this month on a house in Las Vegas a year after a bankruptcy and two years after losing two Florida houses to foreclosure.

“They’re big grown people in their 70s and they don’t want to rent,” Piette said. “They’re taking this on as a purgatory loan and they will refinance when they can.”

Borrowers willing to wait will likely find they can access better rates.

“Moving farther away from the point of foreclosure is going to help a lot of customers,” Ezra Becker, vice president of research and consulting at TransUnion, one of the three major credit bureaus. “One of the great tenets of credit is that time heals.”

To contact the reporter on this story: Prashant Gopal in Boston at pgopal2@bloomberg.net

To contact the editors responsible for this story: Kara Wetzel at kwetzel@bloomberg.net; Rob Urban at robprag@bloomberg.net

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