Short Sale vs. Foreclosure
Questions and Answers You Should Know
1. What is a foreclosure? Foreclosure is the process where a lender has the legal right to take possession of a property if the homeowner has failed to live up to the commitments as outlined in the mortgage agreement. Usually missing payments will trigger this process. The foreclosure process can begin as soon as you are behind on your payments; however, it has been taking longer for the lenders to start this process because of the recent rash of foreclosures. The foreclosure timeline can also be extended considerably by asking the court for extensions.
2. What is a short sale? A short sale is a phrase used to describe the sale of a home for less money than is actually owed on the mortgage(s). Another common term to describe a short sale is being “upside down.” This is done by the buyer providing proper documentation to the bank or mortgage lender to convince them to reduce the mortgage balance to allow the sale. The lender actually takes a loss on the mortgage because the value of the home has fallen below the mortgage balance AND the homeowner is in a poor financial condition that will not allow him to continue to pay on time. If the lender approves the discount on the mortgage, the home can be sold for a lower price without the seller having to come up with cash to cover the shortfall, and mortgage is satisfied and the foreclosure process stops.
3. Why would a bank or mortgage lender want to do a short sale? Banks do not want to own real estate, they want to lend money and collect interest. When a bank takes a property back by foreclosure, it is a long and expensive process and often results in holding the property in their inventory as a non-performing asset. Banks have a limited amount of non-performing assets they want to hold. Once this limit is exceeded, they have strong incentive to get rid of the properties at discount prices. For a lender, doing a short sale avoids many of the costs associated with the foreclosure process. Attorney fees, delays from borrower bankruptcy, damage to the property, cost associated with resale, property tax, insurance, etc. all must be paid by the bank during a foreclosure. In a short sale, the lender is able to cut its losses by getting rid of the property faster.
4. How do I, as a homeowner, benefit from a short sale? First and foremost, it relieves the stress of being in foreclosure and being hounded by the mortgage lender, and it allows you to get rid of your mortgage payment and move on with your life. A short sale allows you to stop the foreclosure and get a fresh start. This is the primary benefit to you. A short sale also prevents additional damage to your credit. Having some late payments and a foreclosure filed has already done damage to your credit. However, a complete foreclosure will do much more damage and lower your credit score tremendously. A short sale results in the mortgage actually being paid off, which reflects positively compared to a foreclosure.
5. Will a short sale “save my credit”? The short answer is yes and no, a short sale can save you from the worst credit disasters. By defaulting on mortgage payments and/or having a foreclosure filed against your property, you have already done damage to your credit. Your credit score has declined and those negatives will stay on your credit report for some time. However, it will get much worse if you allow the foreclosure to continue and do not try to short sale the property. Once a foreclosure property is sold at auction, your credit score is further reduced and when the foreclosure is completed by evicting you from the home and repossessing it, your credit will be even further damaged. If you can complete the short sale before either of these takes place, then you can prevent that further damage to your credit. In addition, when the short sale is completed, it shows up on your credit as “paid” mortgage and a canceled foreclosure, which shows future creditors that you did take care of your obligation.
6. Do I qualify for a short sale? Each situation is different and must be evaluated individually. If you believe you fit the basic criteria of:
You are a good candidate for a short sale.
7. How much does it cost me to do a short sale? There is no cost to you. Essentially the homeowner walks away paying nothing. The lender pays all the required fees and commissions. It is also important to note, in no case may the homeowner walk away with any proceeds from a short sale.
8. Is my house too cheap or too expensive to do a short sale? Homes in any price range can be eligible for a short sale.
9. I am behind on my mortgage payments, but not yet in foreclosure. Can I do a short sale? Yes, this happens quite frequently. Sometimes these are actually the most attractive short sales for an investor and a lender because the lender can avoid all the costs of foreclosure with a short sale before foreclosure is filed. It is important to have a very good “hardship” letter to explain to the lender why you are unable to make the payment.
10. I have received a notice that the foreclosure process has started. Is it too late to do a short sale? Time is of the essence when doing a short sale on your home. You have probably received a Lis Pendens (Latin for suit pending), which is a legal notice, filed with the Clerk’s office notifying you that the foreclosure process has started. If you act quickly, doing a short sale may still be an option for you. We can contact your lender and see where they are in the process, and if we act aggressively, we may still be able to help you. Every day we have to work on the short sale for you is valuable the closer you get to the actual eviction and foreclosure.
11. What is the exact process to complete a short sale? A lengthy package of documents needs to be assembled to prove to the lender that you can no longer make you payments. Most of these documents are the same ones used to qualify for the loan, ie: pay check stubs, bank statements, a personal financial statement and monthly budget assessment, amongst other things. With this information you are proving that you can no longer afford the home. In addition to those financial documents a hardship letter needs to be prepared explaining what caused the financial hardship. Also, market trend reports, recent sales, market analysis, and any other statistical information that can be provided to help make the lender determine why they should accept a short sale. The home has to be on the market for sale and you must be able to show a concerted effort to sell the home at market value. This is done through MLS. Once an offer is received and signed, the valid purchase and sales contract, along with a preliminary HUD-1 settlement statement and a preliminary estimate of proceeds will need to be sent to the lender. In addition your financial information that we will have been collecting all along will be sent to the lender. It’s not as complicated for you the seller as it sounds. We will walk you through the process and will begin getting the items that the lender will require from you up front, so once we get an offer, we can quickly compile the information required to send to the lender with the offer.
12. How long does a short sale take? A short sale is a very complicated process. Once an offer is received on your home it can take anywhere from 30 – 60 days (sometimes more) to get an answer from the lender as to whether they will accept the offer. Once the contract is agreed to by both sides, the closing usually happens within 30 days.
13. I have filed for bankruptcy, can I still do a short sale? Most lender would not consider a short sale if the homeowner is in the middle of a bankruptcy proceeding. Negotiating a short sale between the parties is considered a collection activity and such a negotiation is prohibited in bankruptcy.
14. What are the tax implications of a short sale? A short sale represents a loss for the lender, and the amount that the lender is short is treated as a profit to the homeowner. The bank may issue a 1099. If a 1099 is filed, the seller may be responsible for paying taxes on the amount of debt forgiveness.
Credit Implications As with any financial transaction there are certain credit score implications that come attached. When one gets involved in homeownership or investment property, you hope to build your credit score in the hopes of moving on to bigger and better things in the future. The caveat is if something goes wrong the opposite effect is the result.
2 Years vs. 10 Years Your credit will be marred whether you decide to let the bank foreclosure or the property is sold via a short sale. However, you can begin effective credit rating recovery after 2 years with a short sale. A foreclosure will adversely affect your credit score for up to 10 years. Often time after a foreclosure the homeowner has to file bankruptcy, the proverbial double whammy.
Lifetime Yes There are only two things that follow you for the rest of your life, a felony conviction and a foreclosure. True after 10 years it will drop off your credit report, however, almost every lending institution has the magic question – Have you EVER had a foreclosure? If you’ve had one you must answer yes, answering no could be considered fraud and that would open you up to a host of other legal problems.
50 vs. 300 A short sale can shave as little as 50 points off your credit score. Only the late payments are reported. A foreclosure will take 300 points off for each loan foreclosure. Properties with two mortgages can see the owner lose up to 600 points off their credit score. You can see why a bankruptcy filing soon follows a foreclosure.
Deficiency Judgments After a foreclosure the bank will sell the property to recoup their losses. The proceeds of the sale will be subtracted from what was owed plus all expenses. (Holding costs, attorney’s fees, repair costs, etc.) If the bank is unable to recoup all their losses, they have the right to file suit against the former owner for the shortfall. So just because they took back the property, all is not said and done. The foreclosure can haunt you for years to come. The lender can file a deficiency judgment with a short sale too, however, the judgment itself gives the lender the right to recoup the monies, the process itself has to be undertaken by the bank. This gets expensive and most times they seek the judgment just so they have the flexibility to go after the homeowner in the future.