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The Department of Housing and Urban Development (HUD) released a letter to lenders regarding borrower eligibility for a new Federal Housing Administration (FHA) mortgage after pursuing a short sale.

According to the letter (available to download here) and effective immediately, borrowers are not eligible for a new FHA mortgage if they pursued a short sale agreement “to take advantage of declining market conditions” or to purchase another property at a reduced price.

Borrowers are cleared for a new FHA-insured mortgage if they were current on their previous mortgage and other debts at the time of the short sale and if the proceeds from the short sale serve as payment in full.

If a borrower executes a short sale while in default on their mortgage would not be eligible for a FHA-insured mortgage for three years from the date of the pre-foreclosure sale. Some lenders can make exceptions if the default was due to circumstances beyond the borrower’s control such as the death of the primary wage earner.

But, it means that anyone eligible for the Home Affordable Foreclosure Alternatives program (HAFA) would not be eligible for a new FHA-insured mortgage for three years. Under HAFA, the US Treasury Department provides incentives to servicers, banks and investors to pursue a short sale for seriously delinquent borrowers.

The FHA will insure the first mortgage where the existing not holder wrote off the debt  that cannot be refinanced into the new mortgage because of a decline in property value or a reduction in income.

Write to Jon Prior.