The Impact of Short Sales vs Foreclosures on Credit Reports

If you are a seller whose home cannot sell due to the market declining, and like many others you’ve been turned down for a loan modification, you may wonder if allowing the home to go into foreclosure is easier and smarter than attempting a short sale (short sale vs foreclosure). In the case of a foreclosure, and depending on the foreclosure laws of your state, you may be able to stay in the home without making payments for up to a year before being foreclosed on and forced to vacate. But does that mean a foreclosure is better? Of course not!  

What is a Short Sale

A short sale means that the mortgage amount is larger than the market value of the home. The short sale can happen when a lender agrees to accept less than the amount owed against the home because there is not enough equity to sell and pay all of the costs of the sale.

Will Your Lender Negotiate a Short Sale

Lenders are in business to make money and by agreeing to accept a ’short’ pay off, they are agreeing to take a loss on the sale of the property. You can’t just decide you’re going to sell your home at a loss by asking for a short sale and ask the lender to take the hit with you. To qualify for a short sale a bank will want to see a clearly demonstrated “financial hardship“. Acceptable financial hardships include; relocation, loss of a job, payment increase or mortgage adjustment, business failure, reduced income, to much debt, illness or death, divorce, damage to property, incarceration, etc. Furthermore, if your payments are current, there is very little reason for the lender to consider a short sale. If your payments are behind, then a lender may be more agreeable to negotiate with you.

* In a short sale the mortgage lender pays all of the costs associated with the sale including Realtor commissions, title and escrow fees, as well as back taxes, homeowner association dues, etc. As such there is NO OUT-OF-POCKET EXPENSE TO YOU THE SELLER!

In addition, the bank will allow you to stay in the home while the short sale is negotiated and while your agent works on locating a buyer for your home. As such this period offers homeowners a great opportunity to save the money they would typically be paying towards their mortgage and use this to pay down debt, or rebuild their reserves. It should also be mentioned, that the Obama Administration has recently initiated a short sale program called the HAMP Program that would provide up to $1,500 to homeowner’s to assist with their relocation expenses. Contact us for further details on this program.  

Is the Seller’s Credit Affected

Sellers will take a bigger hit on their credit report if they go through foreclosure or give the lender a deed-in-lieu of foreclosure. The points lost on your FICO score may be as follows:

  • Foreclosure or Deed-in-Lieu of Foreclosure
    Both of these solutions affect credit the same. A sellers can take a hit of 250 to 280 points. This means if a seller’s FICO score before foreclosure is 680, it could dip as low as 400.
     
  • Short Sale
    The damage to a credit report from a short saleis much less drastic. The hit will be indicated as a “pre-foreclosure in redemption status”, or if your real estate agent knows what they are doing and can get the bank to agree to it that an account that has been “paid in full”. Therefore, the loss of points will be more like 80 to 100.

Waiting Period Before Buying Another Home

Short Sale & Foreclosure Deficiency Judgments

You may have heard that some banks may attempt to pursue the seller for a deficiency judgment for the difference between the loan amount and the amount collected through the short sale or foreclosure. It is entirely up to the lender as to determine if they will pursue a deficiency judgement, however, homeowners need to understand that the handling of the deficiency is part of the short sale negotiations and it is the charge of their Realtor to require that the bank agree to accept the reduce payoff as payment in full, and agree not to pursue the owner for a deficiency. There are only a handful of lenders engaging in the practice of pursuing homeowners for deficiencies as the majority appreciate the homeowners cooperation and assistance in helping to sell the home as quickly as possible and for top dollar. That said, we will work to ensure your lender accepts our terms and agrees to forgive the deficiency.

You may have heard that there are tax consequences to short sales, however, in December, 2007, Congress acted to protect many debtors from income tax liability associated with foreclosure avoidance. The Mortgage Forgiveness Debt Relief Act of 2007 states that homeowners will not be subject to income tax from release from mortgage liability if and to the extent the mortgage proceeds were used to buy or improve their primary residence. The act does not provide income tax shelter from forgiveness of mortgage debts for investment property, vacation homes, or mortgages used for businesses or to pay off credit card balances. The protection expires in December, 2012. You should speak with an attorney or CPA familiar with the new law to see if you qualify for income tax protection.

For those borrowers who do not qualify for protection under this Act there is an insolvency exception to imputed income from the cancellation of mortgage debt. If a borrower is financially insolvent when he surrenders the mortgaged property to the lender voluntarily or through foreclosure there will be no imputed income. For those considering bankruptcy, a borrower who files bankruptcy is presumed to be insolvent, and thus a bankruptcy debtor cannot suffer imputed income tax liability because the bankruptcy discharges personal liability under a mortgage note.

Hardship Letter

To begin negotiating the short sale with a lender (ie. the short sale process), a seller must have the home listed, and have a buyer present an offer. The lender will request a short sale package, which will include a hardship letter. That letter must describe the unfortunate conditions that caused you to not be able to keep the payments up. Those reasons could include the loss of a job, a serious medical condition, or any of the other fore-mentioned acceptable hardships. The lender simply wants to see their is a legitimate reason why you’re unable to keep up with the payments.

Being a loose spender and having overextended one’s credit may not be considered a hardship by the lender.

Expect Hardball Tactics

The lenders do not want to lose money… however, they would much rather make a deal with you in an effort to avoid having to foreclose on the property as this is an expensive and time consuming process and they realize that in most instances they can reduce their losses by agreeing to accept a short sale. But that does not make them a pushover. It is extremely important that you located a Realtor who specializes in these types of transactions and one who is experienced in the listing and marketing short sales, and negotiating these types of sales with the bank. While the bank will be responsible for the cost of your agent’s commission, the agent will represent you and fight to protect your interest.

* The agent you select represent you and to assist you with the short sale of your home will be required to sign a listing agreement with you, as such their fiduciary obligation is to you and they are legally required to represent you and your best interests. To put this simply, the agent owes his allegiance to you the homeowner and not the bank. 

Seek Help Early

As soon as you recognize your problems, seek help immediately. The lender may negotiate a new loan with better terms if approached early enough. Obtain the advice of a tax accountant, and attorney or a real estate agent who is knowledgeable about short sales. The major advantage of going through with a short sale is to maintain your credit to as high a level as possible, while at the same time buying yourself more time in the home and helping the bank reduce it’s loses.

Foreclosure prevention alternatives are available…  Regardless of your financial circumstances or lack of home equity!  It is our goal to assist you in resolving your mortgage delinquency BEFORE foreclosure proceedings actually commence, however, if you are well into the foreclosure process already, viable options for avoiding foreclosure are still available and we can help!  Now more than ever, lenders are willing to grant you additional time to remedy your mortgage default if you are willing to cooperate and they feel they can avoid foreclosing on your property altogether.

If you are a homeowner who feels they might qualify for a loan modification or short sale please give us a call as we’d be happy to assist you in your efforts to understand your options and in determing which option is the best for you! All consultations are COMPLETELY CONFIDENTIAL and ABSOLUTELY FREE. 

If you are a buyer, or an investor interested in receiving short sale or foreclosure lists, or purchasing a short sale or bank owned property, please give us a call as we’d be happy to assist you as well!

The Opland Group Specializes in Real Estate Sales, Luxury Home Sales, Short Sales in;  Bexley  Columbus  Delaware  Downtown  Dublin  Gahanna  Grandview Heights  Granville  Grove City  Groveport  Hilliard  Lewis Center  New Albany  Pickerington  Polaris  Powell   Upper Arlington  Westerville  Worthington