Losing your home to foreclosure is one of life’s most unpleasant experiences. In addition to the current disruption of your life, it can keep on affecting you long after your home is gone with a major impact on your credit score. Events such as a serious illness, a major accident, divorce or job loss can happen to anyone and put you in a situation where your house is now in jeopardy. Therefore, it’s a good idea to understand the available alternatives should you face this situation.
The first thing – of all available options, foreclosure is the worst.
The inevitable result of a foreclosure is the lender taking your house. If that isn’t enough, your credit report will reflect a negative condition for many years to come, worsening an already bad financial situation and making it very difficult to obtain any other kind of credit. Most lenders in California with a mortgage in first lien position will do a non-judicial foreclosure – which will prevent it from coming after you for a deficiency if the house sells for less than what is owed. However, if the lender is a second mortgage or HELOC loan, they usually will not receive anything in the foreclosure sale by the first lien holder. If they are still owed money after the first mortgage holder forecloses, the second mortgage holder can sue and get a judgment against you for the amount still owed and can collect on that judgment by a garnishment of wages or bank accounts. In most circumstances, the only way to get out from under this debt is by either paying the judgment (or an agreed amount in compromise) or by discharging the debt in bankruptcy. There is no upside to foreclosure.
While it is more time consuming, you may want to instead consider a short sale when foreclosure seems the only other option.
A short sale is a popular way for homeowners to get out from under a mortgage debt. With a short sale, you sell your home for less than what you owe your lender. However, you are not allowed to receive any money from the proceeds of the short sale. The biggest obstacle with a short sale is getting your lender to agree to a short sale and the approving the amount of the sales price. Because it may take many months to get a short sale approved, you should pursue a short sale as soon as you know you will soon fall behind, or have already have fallen behind, on your mortgage payments and see it is unlikely that you will ever catch up. The longer you wait and the greater the amount you are in arrears, the less likely it becomes that your lender will even be willing to discuss a short sale and may want to just go to foreclosure even if the lender may make more money from a short sale.
A short sale has disadvantages though. While a short sale will save you from foreclosure, which is a far worse impact on your credit rating, it will still have a negative effect on your credit score, frequently lowering it by as much as 200 points. While trying to sell your house at a price less than what is owed, the process is a sale just as if your selling for a profit, including prospective buyers coming through your home, real estate signs and open houses. If you have a second mortgage loan or HELOC, you may also have issues with getting it to approve a sale, if it will require some money being paid to it, thereby releasing its lien. The goal with second lien holders in a short sale situation is to have it release its lien in order for the sale to go through. That does not necessarily mean they are also forgiving the rest of the debt. Borrowers need to make sure the second position lender does not thereafter have the right to pursue you for the unpaid balance or request that you sign a promissory note to pay some or all of the unpaid balance over the next ten years. Further, there may be tax consequences as the difference between the mortgage balance and the amount realized from the short sale may be taxable as income despite the fact that you did not receive any money out of the short sale. This is what is referred to as “forgiveness of debt income.” Currently, there are certain conditions under which a short sale will not be considered taxable income. You should first discuss this with you tax advisor to determine if you qualify to have all or part of that amount not considered to be taxable income under the Debt Relief Act 0f 2007.
Whether you should do a short sale or let the home go to foreclosure depends on several factors. While for some homeowners it is easier to throw up your hands and let the bank take your home, that might not be the wisest thing to do.
Short Sale Benefits
- You are in control of the sale, not the bank.
- You may sleep better at night knowing who is buying your home.
- You will spare yourself the social stigma of the “F” word, foreclosure.
- Contrary to popular belief, you can be current on your payments and still effect a short sale.
- Your home sale will be handled like any other home sale. To the rest of the world, it looks like you sold your house, moved out and someone moved in just like in a traditional sales transaction.
Buying Again After a Short Sale
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. The wait for an FHA loan is 3 years.
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.
Buying Again After a Foreclosure
With certain restrictions, you may be eligible to buy another home in 4-5 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.
A short sale is not a derogatory mark on your credit because credit bureaus do not have the term “short sale” on your credit report. It may say “pay as agreed” or “paid as less than agreed,” among other categories. Some clients have reported negative FICO score drops from 50 points to 130 points. The point drop is typically due to having been behind on your payments. Lenders will report short sales differently and some do not report them to the credit bureaus at all.
Credit scores drop from 200 to 400 points after a foreclosure. Generally, as a foreclosure is a public record, the record of a foreclosure will remain on your credit report for 10 years.
For more information on credit scores and how they are calculated, visit the “credit education center” at www.myfico.com.
Future Loan Applications
Loan applications do not ask questions about a short sale. You may report that you sold your home. In almost every credit or loan application appear the following question: “Have you ever had a property foreclosed upon or given a deed-in-lieu thereof in the past 7 years.” If the bank or credit card company sees you have had a foreclosure on your application, your loan most likely will be denied. If you lie on your mortgage loan application, you may be subject to investigation by the FBI for mortgage fraud.
Despite all of your efforts, if your lender has not, or will not, approve your short sale and wants to take your house to foreclosure, depending on you other financial circumstances, you may want to consider bankruptcy as an option. If foreclosure is the apparent direction you are heading, bankruptcy may allow you to keep control over when and how a foreclosure occurs, or provide you an avenue to keep your home. Further, the impact on your credit of a bankruptcy versus a foreclosure – with other financial problems as well – may not be any different, and a bankruptcy may help in closing out that chapter of your financial life and allow you to move forward to rebuilding credit right after discharge. Also, any second mortgage holder who may sue or is threatening to sue on their loan can be discharged in a bankruptcy along with credit card debts and medical bills.
Jeffrey D. Schreiber is a licensed California real estate broker.
The Law Office of Jeffrey D. Schreiber has successfully counseled homeowners in dealing with short sales and short sale issues, foreclosures and bankruptcy options to resolve their mortgage loan problems.