Short Sale and Foreclosure – Tough Options with Long Lasting Impact on Your VA Mortgage Loan Options

By Douglas Katz – 05/14/2023

For military service members and veterans, the opportunity to become homeowners is a cherished benefit offered through the Department of Veterans Affairs (VA) home loan program. The VA loan program provides accessible mortgage options with favorable terms and benefits. However, circumstances can arise that lead to financial hardship, such as short sales and foreclosures.  We are already seeing an increase in foreclosure activity that was minimized during COVID and we are possibly on the cusp of a recession.  There will be more and more homeowners facing this situation, especially of they bought at the peak and end up impacted by economic conditions.

The impact of a decision to short sale or to send in the keys to a home and give it to the bank is significant for all loan types, but VA is unique in some of the specific issue that accompany this decision.  I have seen more situations than I like to remember where a veteran made the decision to short sell their property or give up the house where they did not know all of the ripple effects of the transaction and only find out later that their options are curtailed for future VA loans, if they can get a loan at all.

If you are a veteran and facing these issues, it is a necessity that you at least have a working knowledge.  It is dangerous to solely depend on the competency of others and too many well-meaning professionals, like attorneys, CPAs or financial advisors, make the recommendation without knowing VA well enough to advise on the impact.  They solve the immediate problem because, but they create challenges down the road and the veteran does not know any better.  In this article, we will delve into the impact of these events on VA eligibility and shed light on the potential consequences for individuals who experience such situations.

Understanding Short Sales and Foreclosures

Before exploring their impact on VA eligibility, it’s essential to understand what short sales and foreclosures entail.

Short Sale

A short sale occurs when a homeowner, with the consent of their mortgage lender, sells their property for less than the amount owed on the mortgage. This option is often pursued when the homeowner is unable to meet their mortgage obligations and is facing imminent default.

In a short sale, the lender agrees to accept less than the full amount owed on the mortgage as a way to avoid the potentially lengthy and costly foreclosure process. The lender may approve a short sale if it determines that it would be more financially beneficial than proceeding with foreclosure.

Foreclosure

Foreclosure is a legal process initiated by the mortgage lender to recover the property when the borrower fails to make mortgage payments. It typically involves the forced sale of the property to repay the outstanding debt.

Impact on VA Eligibility

The VA loan program holds certain eligibility requirements, and experiencing a short sale or foreclosure can affect an individual’s eligibility in several ways:

  • Loss of VA Entitlement: In many cases, a short sale or foreclosure may result in the loss of a portion of the borrower’s VA entitlement. VA entitlement refers to the guarantee provided by the VA to lenders, which enables borrowers to secure favorable loan terms.  If a loss of entitlement occurs, it will limit the borrower’s ability to obtain future VA loans even of they have great credit, income and assets. To be clear, this means that the 100% financing that VA is known for would no longer be an option.  The times that I have see this affect veterans, they saw a bite out of their entitlement equal to the loss on the guaranty from last loan that had the short sale or foreclosure.  It is crucial to consult with a VA representative or lender to understand the specific impact on entitlement and explore available options for recovery.
  • Waiting Periods: Following a short sale or foreclosure, a waiting period is typically imposed before an individual can be eligible for a new VA loan. This applies to ANY loan with a short sale or foreclosure meaning that these type of actions on any conventional or other government loan will have an impact on the new approval even if they are in no way VA affiliated.  The duration of the waiting period depends on various factors, including the circumstances surrounding the sale or foreclosure, the type of loan, and the borrower’s financial history.
  • Credit History: Both short sales and foreclosures have a negative impact on an individual’s credit score and history. A significant drop in credit score can affect eligibility for not only VA loans but also other types of loans in the future.  Because this is just reporting of data, you will not likely have an ability to do anything about the drop and the presence of derogatory information in the report itself.  Individuals who have gone through a short sale or foreclosure need to focus on timely payments, responsible financial behavior, and reducing debt can help in reestablishing a positive credit history. 
Options for Recovery

While the impact of short sales and foreclosures on VA eligibility can be challenging, it is not the end of the road. There are avenues to recover and regain eligibility:

  • Timely Payments: Making consistent, on-time payments for other debts, such as credit cards, auto loans, and student loans, can demonstrate financial responsibility and contribute to rebuilding credit.
  • Credit Counseling: Seeking professional assistance from credit counselors or financial advisors can help develop a strategic plan for improving credit scores and managing debts effectively.
  • Demonstrating Stability: Demonstrating stability in employment and income, along with a responsible financial approach, can enhance the chances of regaining VA eligibility in the future.
  • Exploring Alternative Loan Options: If the waiting period after a short sale or foreclosure is still in effect, exploring alternative loan options, such as FHA loans or conventional loans, can be a viable choice until VA eligibility is reestablished.
Foreclosure and Short Sale – Know Before You Act

Short sales and foreclosures can have significant consequences for VA eligibility. The waiting periods, credit score impact, and scrutiny of financial responsibility may pose obstacles for individuals seeking to obtain a VA loan in the aftermath of such events. Most importantly, loss of your VA entitlement can permanently close the door on VA as an option.  However, with careful financial planning, responsible credit management, and time, it is possible to rebuild credit and regain eligibility for VA loans. If you find