Image courtesy of Flickr, Bradley Gordon
If you're faced with either a foreclosure or a short sale situation and aren't sure what to do, read on. We asked some experts which one is worse.
You might have thought that you became a homeowner the day you closed on your home, but that wasn't exactly the case. Although your status became ''homeowner'' as opposed to, maybe, '' renter ,'' you don't really own the home if you have a mortgage. A more accurate term for what you became that day would be ''home borrower.'' This isn't just being picky about semantics. There's a reason for the distinction.
Another option that may be available to you if you can no longer (or no longer wish to) make your mortgage payments is a short sale . A short sale occurs when you sell your home for less than what you owe. Your lender must be on board with this for it to happen.
So which one is worse: foreclosure or short sale? Here are five considerations.
Your credit score will take a hit, and a huge hit at that, whether you have a foreclosure or short sale on your credit report. ''They are pretty much equally rotten as far as your credit score is concerned,'' says David Reiss , professor of law at Brooklyn Law School.
But just how rotten are foreclosures and short sales to your credit? You can probably count on your score tanking somewhere between 100 and 160 points. And like the saying, ''The bigger they are the harder they fall,'' the higher your credit score was before the foreclosure or short sale the larger the drop will be. But the good news is that with either a foreclosure or a short sale, you can start to see your score rise in just a couple of years if you continue to pay all your other bills on time, according to myFICO , the consumer division of FICO .
If you wish to get back into the housing game some day, whether you went through a foreclosure or a short sale matters to many lenders. ''There's not as much of a stigma involved in selling a house via short sale as there is in losing it in a foreclosure proceeding,'' says Rick Sharga, chief marketing officer at Ten-X, an online real estate transaction marketplace. ''A short sale indicated that the borrower was willing to work with the lender, and in fact, an active participant in trying to come up with a solution that worked as well as possible for all parties.''
'' Fannie Mae and Freddie Mac treat a foreclosure as worse than a short sale when it comes to future lending,'' says Reiss. ''Fannie, for instance, won't buy a mortgage from a lender who lent to someone who has gone through a foreclosure in the past three years in some cases (but as many as seven), but reduces that bar to two years for a short sale.'' This is significant when you realize that Fannie and Freddie back almost 90 percent of mortgages , according to CNBC.
With a short sale, you arrange for a buyer, and the lender must approve the deal. The bank handles the sale of the house in a foreclosure. When you go through either, your lender is usually out some money, called a deficiency. For example, if you owed $350,000 on the house, but the house sells for only $300,000, there is a deficiency of $50,000. The lender, in both foreclosure and short sale situations, wants to get as much of their money back as possible.
Sacha Ferrandi, founder of Source Capital Funding, Inc. , a direct hard money lender , shares his thoughts. ''Short sales have fewer legal issues. One of the biggest problems with a foreclosure is the potential litigation and legal fees that are associated with the process. The lender does not want the foreclosure to happen and will almost always take legal action to get the most out of their investment. However, with a short sale, the lender approves the sale. Because the homeowner is working with the bank or lender to fix the issue, there is much less tension and far fewer legal problems for the homeowner.''
Whether the lender can sue you for a deficiency, however, depends on certain issues. For example, where you live is one consideration. Some states prohibit lenders from going after a borrower's deficiency. In other states, how lenders can proceed depends on whether your state is a judicial or a nonjudicial state . It's a good idea to discuss with an attorney how the laws of your state affect you.
Tip: If you go through a short sale in a state with no laws on deficiency judgments, have your lender waive the right to pursue you for any deficiency.
Unfortunately, you'll probably experience some stress if you go through either a foreclosure or a short sale. The key is to try to minimize this stress. Here are some considerations.
A foreclosure is typically less stressful than a short sale, but that might be short lived. Ross Kilburn, CEO, Ark Law Group, specialists in foreclosure prevention and short sales, explains why. ''You simply stop making your payments [with foreclosure] and essentially live for free in the house until the bank takes it back. It's a good opportunity to save up money for your next housing situation.''
However, you could be sued for any deficiency, which will be a problem for you down the road. ''Typically houses sold at auction only receive 70 percent to 80 percent of the value of the home,'' says Kilburn. If the bank gets the court to grant a deficiency judgment, here's what you could be in for. ''The bank could come after you for the money, possibly for six years or more. They can sell the judgment to a debt collector who can harass you constantly. They could garnish your wages or attach a lien to other property that you may own,'' says Kilburn.
A short sale tends to be more stressful early on and less stressful later. ''A short sale can often be a difficult process,'' says Kilburn. ''It can take months, and sometimes over a year, to get a short sale approved. Buyers may get tired of waiting and back out. You then have to start the whole process over again.''
But if you're successful with a short sale, it could work out better for you in the end. ''If you have the patience and fortitude to make it through the rigors of a short sale, you will be rewarded,'' says Kilburn. If the bank waived the right to go after you for any deficiencies, you're done. ''You don't have to think about it any more,'' says Kilburn.
Many landlords and property management companies have strict rental rules, such as requiring potential renters to have a particular credit score. If yours falls below their threshold, you're out of luck. But some landlords and property managers might bend the rules if you have a good explanation of why your score is low and if you can prove that you will be able to pay your rent each month and on time. With that said, landlords and property managers tend to view short sales more favorably than foreclosures.
''When I see a completely defaulted loan on a credit report (foreclosure), it is as much as a red flag to me as an eviction,'' says Denise Supplee, co-founder of SparkRental.com. ''When someone fails to pay for their home, the roof over their head, and instead chooses to walk from it, I have to wonder whether they'll do that to me.'' But Supplee feels differently about short sales. ''When I see a short sale, or am told by the applicant that they went through a short sale, I see someone who gave it a try.''
There's no right answer for everyone on whether a foreclosure or a short sale is worse. Evaluate the situation you're in, and weigh the pros and cons of both before you make a decision.
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