by: Michael Creditfirm.
What’s the difference between a Foreclosure and a Short Sale?
Lets start with how they report on your credit file. You can expect a loan in foreclosure to appear on your credit report as a “foreclosure.” But, there is no specific label for a short sale, instead, a loan paid via short sale will be labeled as either “charge off,” “deed-in-lieu of foreclosure,” or “settled for less than the full balance” – all having about the same negative impact on your score as a foreclosure.
Does this mean then that a short sale will always impact your score as much as a foreclosure? The answer is no, depending on other information being reported about the loan, such as the balance, the status, and the past due amount, a short sale may impact your credit score either more or less than a foreclosure. Generally, the higher the balances or past due amounts, the lower the credit score.
To dig a little deeper into the specifics, when a foreclosure is reported by a lender to the credit bureau, the balance appearing on the credit report for that item consists of the entire unpaid loan amount as of the date it went to foreclosure. For a short sale, the reported balance is made up of the outstanding loan amount as of the date of the short sale, less the sale amount received from the buyer and agreed to by the lender. If the difference between the reported balances under each of these two scenarios is substantial — and it should be — the negative impact to the score will be less for a short sale than a foreclosure.
Past due amounts reported for a mortgage loan will impact the score similarly, as a higher past due amount leads to a lower score. Typically, when a loan in foreclosure appears on a credit report, the entire outstanding balance also appears as the past due amount. For a short sale, there should not be any past due amount reported. In this case, she short sale will have a smaller negative impact on a credit score.
But before future short sale sellers get too excited about this seemingly good news, they should also understand that a short sale is ultimately a settlement on an account, and by law, they will receive an IRS 1099 form for the amount they did not pay. The Short-Seller will have to pay taxes (which can be as much as 33%) on the remaining balance.
A Foreclosure has it’s own financial drawbacks in the form of deficiency judgments. Depending on the state you reside in, you may or may not be liable for a deficiency resulting from your foreclosure. Here is a list of state deficiency judgement laws.
In conclusion, it is not a good idea to base a short sale vs. foreclosure decision strictly on the anticipated impact to a credit score, when other factors, such as financial liability and the ability to qualify for a mortgage in the future, are likely to affect your finances and general wellbeing long after your credit score has begun to recover.
If you have a foreclosure or short sale on your credit report which is hurting your credit score, contact Credit Firm to find out how we can help improve your credit score.
With rules that take effect next month, federal regulators have hopes of greatly streamlining the short-sale process.
Starting June 15, the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, will require both agencies to give short-sale buyers a final decision within 60 days. (In a short sale, a lender agrees to accept less than the balance on a mortgage.)
Fannie and Freddie must also respond to initial requests for a short sale within 30 days of receiving the buyer’s submission.
“Short sales are huge right now,” said Peter Spino, the foreclosure services manager for Community Housing Innovators in White Plains, N.Y., a housing counselor certified by the Department of Housing and Urban Development. Distressed homeowners often prefer them to a foreclosure, he noted.
Expedited sales as a result of the new directive will benefit the entire housing market, said Michael McHugh, the president and chief executive of Continental Home Loans and the president of the Empire State Mortgage Bankers Association, a trade group. They could also remove some risks for buyers — many of whom previously had to wait months for a decision and then ended up not getting the house they wanted.
In March, the most recent month for which data were available, short sales represented more than 14 percent of existing home sales, according to CoreLogic, a data analytics company, compared with 12 percent for all of 2011 and about 10 percent in 2010. And as the number of short sales has risen, foreclosures have fallen. Completed foreclosures represented 25.3 percent of home sales in March, versus 34.9 percent in all of 2011 and 42.7 percent in all of 2010.
Lenders favor short sales because they are less costly and more efficient than foreclosures. Yet the homeowners, trying to exit as gracefully as possible, never know how long the process will take or how badly their credit will be hurt.
Although short sales have a reputation for being easier on credit scores than foreclosures, “that’s a fairly common misperception,” said Rod Griffin, the director of consumer and public education at Experian, one of the major credit bureaus. If there is a difference in impact, he said, it is slight. Both short sales and foreclosures remain on the credit report for seven years — but foreclosures don’t appear until the legal paperwork is filed, and that could take months, Mr. Griffin said.
The effect was measured in an analysis by VantageScore, a provider of credit scores used by lenders. The higher the credit rating a consumer has, the more points he or she would lose in a short sale.
If consumers started with, say, an 830 score, they would most likely lose 100 to 110 points from a short sale, 120 to 130 points from a foreclosure. But a homeowner with a 625 score, who is behind on his mortgage and some credit card payments, would lose 15 to 25 points from a short sale and 10 to 20 points from a foreclosure, the VantageScore analysis shows.
One major downside to a short sale has been the length of time it takes to process the transaction. “I have done short sales in 60 days, and I’ve also had them take a year,” said Peter J. Goodman, a real estate lawyer in Brooklyn. He typically tells clients to expect them to take 90 to 120 days.
Short sales today are being completed faster than they were a couple of years ago, Mr. McHugh said. About one-fourth of his mortgage business comes from short sales; five years ago it was almost zero.
Speeding up the short-sale process could be especially worthwhile in states like New York, where judicial foreclosures can take a year or longer. “There should be a significant improvement in the turnaround,” he said.