Tuesday, July 10, 2012

Short Sale vs Foreclosure: Which Pill to Swallow?

Being a homeowner today is not easy, unless you own your home outright. For most that make mortgage payments, even if you have sufficient funds to make payments regularly, declining property values have crippled re-financing as a viable option. If you are a distressed home owner and have lost income and can’t make mortgage payments, you can either surrender to foreclosure, whereby the bank or loan company takes legal action to take total control of the property or you can attempt a short sale, whereby the bank agrees to accept less than the total amount owed on a mortgage to avoid having to foreclose on the property.
Being foreclosed has severe consequences to one’s reputation and credit. Participating in a short sale also has consequences, but they are less severe than those associated with foreclosure.
The following compares and contrasts some life options if you do a short sale vs. being foreclosed.

Buying Again: Short Sale vs. Foreclosure

If your payments have never fallen behind 30 days late and the lender does not require that you pay back the loan, Fannie Mae guidelines may allow you to buy another home immediately. Finding a lender who will fund that kind of loan is very difficult. If you are current on your mortgage, you can qualify for an FHA loan immediately as well, but lender requirements can be weird such as you have to move more than 600 miles away.
If your payments are in arrears yet a short sale is granted by your lender, you may qualify to buy another home with a Fannie-Mae backed mortgage within two years, regardless of whether the home is your primary residence. The wait for FHA is 3 years.
With certain restrictions, you may be eligible, after having your home foreclosed, to buy another home in 5 years if the home was your primary residence. Without restrictions, the wait is 7 years.
If you are an investor and do not occupy the home, the wait to buy with a Fannie Mae insured loan is 7 years.

Affects on Credit: Short Sale vs. Foreclosure

A short sale may be considered to be a derogatory mark on your credit even though credit bureaus do not show the word "short sale" on your credit report. It may say "paid in full for less than agreed" or "settled for less," among other categories. Some clients have reported negative FICO score drops from 50 points to 130 points.
Major point drops are typically due to being in default, meaning you have fallen behind on your payments.
Depending on your credit history and other guidelines, a credit score could fall 105 points to 160 points after a foreclosure. Generally, a foreclosure will remain on your credit report in the tradelines section for 7 years.

Credit Reports: Short Sale vs. Foreclosure

All lenders report short sales differently, with many reporting "paid in full for less than agreed," and some report the short sale as a charge off. Negative credit, however, stays on your report for 7 years. If a prospective employer runs a credit check on you, your job application may be denied if you have a foreclosure on your record.

Deficiency Judgments: Short Sale vs. Foreclosure

Judgments are often negotiated between the seller and the short sale bank. In some cases, such as California, if the home is your personal residence and was financed through purchase money, there is no deficiency judgment. Banks are generally unwilling to negotiate deficiency judgments with the homeowner after a foreclosure. In California, for example, according to the California Association of REALTORS, a deficiency judgment may be filed regarding a hard-money loan if the lender forecloses under a judicial foreclosure versus a trustee sale or if the second loan is a hard money loan and the sale takes place as a trustee's sale.

Loan Application Questions: Short Sale vs. Foreclosure

Loan applications do not ask questions about a short sale. You may report that you sold your home. However, you are required to answer the question: "Have you ever had a property foreclosed upon or given a deed-in-lieu thereof in the past 7 years." If the bank sees you have had a foreclosure, your loan most likely will be denied. If you lie, you may be subject to investigation by the FBI for mortgage fraud.

Length of Time to Move:  Short Sale vs. Foreclosure

If you've had a foreclosure notice filed, you may be able to postpone that action while the bank considers your short sale. The wait for short sale approval can be from 2 to 3 months, or longer. Unless prior arrangements have been made, the bank may want you to immediately vacate the property and can commence eviction proceedings.

Taxation: Short Sale vs. Foreclosure

A personal residence is exempt from mortgage debt relief until the end of 2012 on a federal level. Some states will still tax you unless you qualify for an exemption. An investor is not exempt from mortgage debt relief, subject to certain conditions.

A person who has had their home foreclosed, is protected under the mortgage debt relief act that is in place until the end of 2012. Nevertheless,  some lenders immediately send out 1099s, even if the owner is exempt.
Going for a Short Sale: Time is of the Essence
To qualify for a short sale your home must be worth less than you owe on it, and you  must be able to prove that you are the victim of a true financial hardship, such as a decrease in wages, job loss, or medical condition that has altered your ability to make the same income as when the loan was originated. Divorce, estate situations, etc… also qualify.
As a seller of a property you should never have to pay for any short sale cost upfront to any professional service. Realtors charge a commission that is paid for by the bank. In most communities there are also non-profits and HUD counselors who can help you with foreclosure prevention options for free. The only potential cost you could incur is if the bank would not release you from a deficiency balance in the short sale, which is happening less and less now.
The farther you get behind on your payments, the harder it is to get a short sale approved. The closer a property gets to a foreclosure the harder it is to convince the bank to perform a short sale; as they get closer to a foreclosure sale more money is spent, thus deterring them from doing a short sale.
If you think you need to perform a short sale, time is of the essence; the sooner you start the process, the better. Waiting too long can trigger the ramifications of a foreclosure, rendering the short sale unviable.


  1. After reading I like to go with short sale.

  2. I find myself reading your blog quite often! Really looking forward to read more.

  3. Well, if your property value is less than your mortgage then you can list your property in short sale.

  4. Recent development in short sale guidelines will allow borrowers current on their mortgage to qualify for short sales as well. There should be a groundswell in new short sale activity as we approach the end of the year.

  5. The following compares and contrasts some life options if you do a short sale vs. being foreclosed.

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  7. Wao... What a great post is this!!! After reading this quality information, I would like to go for Short Sale process for sure. The benefits related to it are just phenomenal. The step by step benefits explained in this post have really impressed me a lot. Thanks for this helpful information.