There are various ways that a financially distressed homeowner can opt for to save their property and successfully do so. However, the circumstances that lead to such instances may not change anytime soon, for example, decreasing property value, reduction in income and sluggish economic growth. In many cases, the best possible option is to get rid of the property and opt for a fresh start. The options, however, are limited to some extent- either negotiate a short sale or wait for foreclosure. Here are the advantages and disadvantages of each alternative.
Taking action
Being in financial distress is never a comfortable feeling. So, it’s better to take charge of the situation and work towards a stable solution via a short sale. Foreclosure, on the contrary, is a waiting game where the lender calls the shots.
Closing the books
When you find yourself at a juncture having to choose between short sale and foreclosure, the evidence is clear that your property has turned into a bad investment. The faster you can get rid of a bad investment, the faster you’ll be able to relocate your resources towards better opportunities. If you work with a well-qualified short sale specialist, the transaction will be completed within two to three months, whereas a foreclosure usually spans over a year. Your priority here should be towards closing your books as soon as possible and focus on the future.
Living Mortgage and Rent free
The main advantage of foreclosure is- once you stop paying off your mortgage, you are basically living mortgage and rent free as long as the whole procedure drags along. Some homeowners even apply for loan modifications (even though being aware that they won’t be approved) to prolong the foreclosure process. Some go to the extent of providing misleading or false information in their short sale applications. However, these tactics are neither ethical nor legal. Also, there is a great deal of uncertainty and stigma associated with foreclosure. The constant probing from creditors, the social embarrassment, even if you are not trying to hoax the system. A short sale is devoid of any such instances.
Deficiency Judgements
The deficiency is the amount of shortfall that arises when repaying a mortgage after a short sale or foreclosure. For example, if the lender’s sale proceeds amount to $150,000 on an overall mortgage owing to $225,000, the deficiency will be $75,000. If your lender waives it off, you don’t need to repay it. However, if your lender attains a deficiency judgment, you will have to repay the shortfall amount at some point in the future. The judgements vary from state to state. If your lender forecloses you in a non-recurse state, your property will be seized and auctioned off to pay the debt. But if the sale proceeds fall short of the total debt owed, they may not recover the deficiency balance from you. However, in a recourse state, a lender might sue you to recover the owed deficiency balance. Some states also prohibit the lender to collect the deficiency balance if the loan was used for purchase.
In a short sale, the waiving of deficiency depends on both the state and the lender. Government short sale programs like HAFA and FHA compels lenders to waive off such deficiency, provided the borrower has acted in good faith.
Credit Score and Credit Report
Leading credit-reporting agencies like Experian, Equifax and TransUnion are notoriously tight-lipped about how they calculate credit scores. So, it can be a difficult task to figure out the effects on a credit score from a short sale or foreclosure. There seems to be a misconception at large, that both the short sale and foreclosure has a similar effect on your credit score.
This misconception is born partly from the assumption that homeowners must default on their mortgage payments before attempting a short sale. However, recent circumstances portray that homeowners can request a short sale from their lenders even before becoming delinquent.
Borrowers who remained current on mortgage payments, the hit on their credit score may be as little as 60 points or less. This record may only span for a period of 12 to 18 months. Borrowers who are behind on mortgage payments, the hit would cost 100 points or more. In comparison, a foreclosure will cost the borrower between 250-300 points, and it will also prevail on the record books for 7 long years. There is no set amount of points you can lose in either cases though, it’s just a simple case of proportion. If you started off with a higher credit rating, you will lose more points and vice versa.
Short sales are generally reported to credit bureaus as “account paid in full with less than full balance” or “legally settled for less than owed”. Most future lenders will consider it to be less detrimental than a foreclosure on your record, as it portrays your effort to act proactively towards a solution in good faith.
So, if you value your credit ratings, it’s crucial to choose short sale over foreclosure. Also, if possible, remain current on your mortgage payments throughout the short sale timeline. Remember, maintaining stable credit ratings goes a long way while obtaining any future financing.
Future Purchases
When you are trying to get rid of your underwater property, purchasing a new one is the last thing on your mind. However, once you have successfully dealt with the situation and your finances, entering the housing market might seem like an attractive proposition. So, it’s important to keep your options open with the choices you make today. It’s simple, if you have remained current on your mortgage payments throughout the short sale, you will immediately qualify for a new home loan after the transaction is completed. However, if you were behind on the payments, you will have to wait for 2 to 3 years before a new lender approves a loan.
On the other hand, if you have faced foreclosure, you will have to wait for almost 5 to 7 years before a lender considers financing you. Only in case of “extenuating circumstances” leading to foreclosure, that is, death of a wage earner, or accident resulting in injury, can such terms be decreased to 3 years.
Stigma of Foreclosure
Foreclosure isn’t everyone’s cup of tea. Some people may welcome it, trying to live rent-free for as long as possible, but for most, the uncertainty and the added stress is too much to bear. Also, add to it the social humiliation in front of your family, friends and neighbors and the huge pressure and moral obligation to fulfill a promise to pay.
Foreclosure might buy you some time, maybe even a year, but it has a profound effect, both socially and personally that you will have to deal with for the foreseeable future.