A pre-foreclosure or a short-sale on a borrower’s credit report can mean the difference between them getting approved for a loan – or finding themselves without the ability to pass underwriting.
Understanding this issue, Fannie Mae is revamping its automated underwriting system, Desktop Underwriter (DU), to ensure lenders have enough flexibility during the underwriting process to approve borrowers who accidentally end up with a foreclosure on their credit report — when in reality, they went through a pre-foreclosure sale.
In many circumstances, a borrower may be qualified to obtain a loan when enough time has passed from the enactment of a pre-foreclosure sale. But there's one major glitch: in some of the credit bureau files, the data offered is undermining the borrower by showing a foreclosure on their records even if the home was technically offloaded in a pre-foreclosure transaction.
Stephen Pawlowski, senior vice president for business solutions initiatives at Fannie Mae, says the GSE requires a two-year waiting period before a borrower can qualify for a loan following a preforeclosure sale. A seven-year waiting period is imposed when a borrower goes through a foreclosure.
But when borrowers who go through a pre-foreclosure sale end up with a foreclosure and pre-foreclosure sale on their credit reports, this technical error can delay their re-entrance into the underwriting process and the housing market.
When both of the actions (including the erroneous foreclosure) show up on credit reports today, Fannie's DU system “applies the more conservative underwriting guidelines and the new seven-year waiting period requirement,” Pawloswski says. The other option is for the lender to manually overwrite the foreclosure, allowing the borrower to access the appropriate two-year waiting time that comes with a pre-foreclosure sale.
The problem is lenders don't want to deal with manually overwriting the system.
John Walsh, president of Total Mortgage, attests to the difficulty of dealing with a foreclosure on a file when the borrower actually experienced a short sale.
"Definitely, there were credit reports showing that even if it was a short-sale, or a pre-foreclosure, it was reading as an actual foreclosure," he explained. "The only way to override it is to do a manual overwrite to Fannie, which nobody does that.”
Making matters worse, many of the investors in the market are still imposing at least a four-year timeframe on borrowers who go through a pre-foreclosure sale, so making it through the GSE’s system in a timely fashion is essential for these borrowers, Walsh explained.
To remedy the problem, starting on Nov. 16, Fannie's DU system will include a feature that allows lenders to instruct the system to ignore foreclosure information received on a credit reports if there is also a pre-foreclosure sale present.
"This change is designed to assist lenders and borrowers in managing inconsistent, incomplete, and conflicting data that appears on the borrower's credit report,” Pawlowski said in a blog. This mechanism allows borrowers who went through a pre-foreclosure sale to obtain the less restrictive two-year waiting period – a move that is a boon for lenders and servicers.
"As a servicer, we focus on foreclosure prevention and loss mitigation efforts," said Gagan Sharma, CEO of BSI Financial. “A pre-foreclosure sale benefits everyone, the borrower, the investors and the community. The decision by Fannie Mae is another way to incentivize borrowers to cooperate with their servicer to do a pre-foreclosure sale as opposed to letting the loan go into foreclosure.”