The Impact of Short Sales vs Foreclosures on Credit Reports

If you are a seller whose home cannot sell due to the market declining, you may wonder if allowing the home to go into foreclosure is easier and smarter than attempting a Short Sale. 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

Many lenders will not negotiate a short sale, therefore, a real estate agent or an attorney can be of assistance to you by contacting the lender's loss mitigation department to find out if they will. 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. 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. And, if you have cash assets, the lender may try to tap those assets.

Is the Seller's Credit Affected

The 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 sale is much less drastic. The hit will be indicated as a pre-foreclosure in redemption status. Therefore, the loss of points will be more like 80 to 100.

Waiting Period Before Buying Another Home

  • Foreclosure or Deed-in-Lieu of Foreclosure
    A seller who wants to buy a home after foreclosure can expect to have to wait about 36 months before being able to get a loan with a reasonable interest rate.
  • Short Sale
    For a short sale, the seller should be able to buy another home with a reasonable interest rate after about 18 months.

Short Sale & Foreclosure Deficiency Judgments

Now for the bad news. A seller may be subject to a deficiency judgment for the difference between the loan amount and the amount paid. If a deficiency judgement is permitted, it is entirely up to the lender as to whether to pursue the deficiency judgement. The major advantage of going through with a short sale is to maintain your credit to as high a level as possible.

Hardship Letter

To begin negotiating with a lender, 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 other legitimate reason for not being able 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. They would, of course, rather make a deal with you instead of having the home foreclose because it is more expensive for them to foreclose, and they will receive less money. But that does not make them a pushover. If you do not declare bankruptcy, they can try very hard to get you to sign a note to pay off the deficiency over a period of time. If you give into this tactic, then it will cost you a lot of money. Your risk is that they may not back down, and you may be forced to declare bankruptcy in order to not have to pay that deficiency. Their risk is that you may go ahead and file bankruptcy, and they will then be stuck with a home that they do not want to own.

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.

For additional information contact contact us to set up a private personalized consultation.