Defaulting on any loan has negative consequences, but not paying a VA loan on time has serious implications. Just like any loan, your credit score will decrease quite dramatically. Whether you give the home up in a short sale or you go through a complete foreclosure, your credit score will suffer. In general, you can expect your score to decrease between 100 and 150 points. However, there are other consequences you will face as a result of letting a VA loan go to default.
Defaulting – Losing VA Eligibility
Perhaps one of the worst consequences of defaulting on a VA loan is the loss of eligibility you face. You have to earn VA eligibility in the first place. This means you have to serve adequate time in order to be eligible. If you served during wartime, you have to serve 90 days to be eligible. If you served during peacetime, you have to serve at least 181 days to secure a VA loan. Once you serve adequate time and have an honorable discharge, if you are no longer active, you receive VA entitlement. You are able to reuse this entitlement throughout your life if you pay off your existing loan and take out a new one.
One way to lose your VA entitlement, though, is to default on the loan. This does not mean just pay the loan late – as long as you make your payments, you can retain your entitlement. It is when you walk away from the home, letting it go to foreclosure that you can lose your entitlement. The amount of entitlement you lose depends on the amount of the mortgage you had written off. For example, if you had $50,000 left on your VA loan, you would lose $50,000 of your entitlement. The basic entitlement equals $144,000. In your case, you would only have $94,000 available.
No matter how much of your VA entitlement you have left after a foreclosure, you have to wait the necessary waiting period. Right now, this means 2 years. This is fairly typical of any loan program; however. They do not want to provide you with a new mortgage too soon after you go through a foreclosure. There was a reason you could not afford the loan before, so the lender needs to make sure your finances changed in order to ensure you can afford a new loan.
Despite waiting 2 years, you still have to take a lower amount of entitlement. The only exception to the rule is if you were able to work out a way to pay the government’s loss back. If you paid back the amount you defaulted on, you may be able to get full entitlement back again.
Making the Most of the Waiting Period
The VA requires a 2-year waiting period for good reason. They need to know that you changed your financial responsibilities in order to afford another mortgage. This takes time and may take even longer than the 2 years they require. You have to build your credit back up. The best way to make things right is to do any of the following:
- Pay any other debts on time. This includes credit card payments, installment loans, and student loans.
- If you don’t have any other debts because you lost them all in a bankruptcy, start applying for small accounts. A department store credit card is a great place to start. You can also apply for a secured credit card.
- If you open new accounts, charge small amounts and pay them off in full each month. This shows new lenders that you have financial responsibility.
Keep in mind, you also have to show that your income increased since the foreclosure. The best case scenario is when you have a one-time occurrence that caused your foreclosure. For example, if you became ill and could not work, this is a one-time occurrence. If you can prove to the lender that you have recovered and are back to work, it could work to your benefit. You have to show the lender proof of the illness with medical records as well as the loss of income you experienced. Generally, they want to see a 20% loss in income in order to consider it a hardship.
Once you get back on your feet and start working again, you can show the lender your new paystubs and ability to make an income again. The lender may also need a statement from your doctor stating that you are capable of working full-time again.
If your default was a result of financial irresponsibility that you cannot tie into any one-time occurrences, however, you could have a harder time securing a new mortgage. Lenders have to be leery of your ability to repay a mortgage, no matter how willing you may seem.
The Lender Overlays
Keep in mind, the VA does not fund the loans – only lenders provide the funds. Just because the VA says you are eligible for a VA loan after defaulting, does not mean every lender will give you a loan. You may have to shop around to find a lender with a higher threshold for risk. If you wait the necessary 2-year period, don’t think you will not get a loan. However, you do have to put the work in; this is how you secure the best deal too. When you shop around, compare the interest rates and closing costs each lender charges. Some lenders may overcompensate for your default by charging a high interest rate or excessive costs. Compare the offers to many other lenders to see who has the best deal for you.
Getting a VA loan after defaulting on one is not impossible, but it does take patience. You have to make sure you are fully capable of taking on a new loan. Not paying a federal debt is a very serious issue that the government does not take lightly. Even though the VA does not provide the loan, they guarantee it, which means they have to pay the lender 25% of the amount you did not pay. The VA and the lenders take a new loan after a default very seriously.