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Short Sellers Banned from FHA Loans

By Faye Mergel
Published: Monday, December 28th, 2009

The Housing and Urban Development (HUD) recently sent a letter to mortgage lenders across the United States informing them that it will not insure loans for short sellers whose mortgage was in default at the time of the sale. However, it also announced that short sellers who managed to keep black marks off their credit report over the last few years may get an exemption.

Short Sellers Banned from FHA LoansPeople are increasingly resorting to short sales in order to avoid foreclosure as more and more American homeowners are finding it difficult to meet their mortgage payment. A short sale mark on a credit report can hurt a person’s ability to get credit but many prefer to short sell their homes because a foreclosure is even more damaging.

Many industry specialists were surprised when, recently, even the federal government has been encouraging creditors and homeowners to go for a short sale when loan modification is deemed a poor option. The Making Home Affordable program is now giving cash incentives to homeowners for short sale transactions. However, the Housing and Urban Development (HUD) does not view the administration’s move favorably and is now locking out some short sellers from FHA-insured loans.

HUD released a mortgagee letter saying it will not grant FHA-secured loans if a homeowner who recently had a short sale was in default during the time of the transaction. Mortgage defaulters during a pre-foreclosure sale will also be locked out from FHA-insured loans.

Analysts explained that HUD does not favor the strategic default done by homeowners through short sales since it could further hurt the already impaired housing industry. The measure is taken because some homeowners do not really resort to short sales because of their inability to meet mortgage payments through no fault of their own. They merely take advantage of the current housing market conditions by purchasing, at a lower price, a similar or better property value at a more comfortable distance.

But the HUD says it will make exemptions to this rule if the homeowner in question shows satisfactory performance as a borrower which can be determined by reviewing his credit report. For a homeowner to qualify for this exemption, he must have been current on his mortgage payment and other debts during the time of the short sale. Additionally, the proceeds must be used as payment in full to the previous mortgage loan.

Some experts criticize the rule though, saying it would only cause foreclosure rates to go up. This will consequently prevent more homeowners from getting better loan deals in the next few years since a foreclosure is considered by creditors as a serious black mark on a credit report.

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