Short Sale vs. Foreclosure: Is there a Difference on Your Credit?
The Story
I had a client call me the other day… his story was similar to many we have all heard over the last year and a half. He had been trying to sell his investment property for over two years but was very resistant to dropping the price, which he recognized was necessary to get any offer of purchase. His life savings had been depleted trying to keep current on this property and he had reached the end of the line. He was depressed, frustrated and resigned to losing the property and taking a credit “hit”. The bottom line for him was whether he should he “go to the trouble of trying for a short sale” or just “let it go to foreclosure”. He definitely wanted the easier road, which he thought would be a foreclosure. The consequences would be similar between the two . . . . right?
What do Lenders Say?
I flashed back to about two weeks prior when I was teaching a Short Sale and REO Transaction class for a local lender. The Senior Loan Officer had some material to share with us. First, she showed us actual credit reports of clients who had gone through a Short Sale. There was a “Before” and “After’ credit report for the same borrower. The Short Sale basically dropped this borrower’s credit score by one hundred (100) points. The mortgage also showed as “Paid in full but settled for less than was owed.”…. Okay, this was kind of what we would have anticipated and is certainly consistent with the information we have received from the lending institutions over the last year. Then we see the real show stopper. The Loan Officer hands out the new Fannie Mae underwriting guidelines that go into effect May 31, 2008. Guess what? The rules have changed.
REALITY BITES
The reality for my client on the phone becomes painfully clear. My advice: You better find a good agent who is competent and experienced in handling a Short Sale transaction. Under the new Fannie Mae guidelines the effect of a Foreclosure on a borrowers’ credit worthiness is substantial, devastating and decisive. A Short Sale may reduce your clients’ credit score and will stay with them for about a one year or twelve month period of time. For all our clients who have “let it go to foreclosure”, I have some very, very bad news. Effective May 31, 2008, according to the Fannie Mae guidelines, a client who has filed a foreclosure will be “ineligible” for a period of five years. That is FIVE YEARS (5 years) for a foreclosure compared with a one year “ineligible” for a Short Sale. That difference is significant and will have an immediate effect on our business.
Don’t be Surprised
It should be no surprise to us that the lending guidelines would adjust. We should have all seen this coming, right? Certainly the prior estimates of a 2 year credit hit for a Short Sale as compared to a 3 year hit for a Foreclosure were astonishing and somewhat unbelievable, leaving many of us to wonder if the effect of either outcome made no significant difference to our Seller, then why did it matter which outcome they pursued? The implementation of these new guidelines solidifies the rules and changes the desired outcome for many of our Sellers. As a result, I think we will all become experts on the Short Sale transaction.
Tags: credit, foreclosure, short-sales
June 20th, 2008 at 9:58 am
An excellent article. Succinct. Informative. A must read!
June 20th, 2008 at 10:35 am
Thanks for the article, but I am still not completely convinced that I can be as excited about telling people if they go through with a short sale, their credit will be repairable so easily and so quickly, as you. Even though I would like to think that. How can anyone be so sure about what a short sale will do to someone’s credit in the future? Case in point…I was in the mortgage business from 1986 to 2003. During that time, I have had applicants fill out the standard Fannie Mae 1003 form (THE application), and one of the questions, point blank, was, “Have you ever had a foreclosure or given a deed in lieu of”? If the applicant marked, yes, it was impossible for them to get a “normal” mortgage. A bank or mortgage lender would not touch them at all, ever, as I was told back then. I had to go to my private investors to help them, with extremely high rates. Most people couldn’t afford the loans. In the last few years, and in my opinion, the reason for some of the mortgage troubles today, is that they loosened that requirement and gave loans to people who were in a sense, credit deadbeats. Once a foreclosure, always a foreclosure - it is easier to walk away a second time. Now with all this mess, do you really think banks and mortgage lenders will continue to give loans to people who go through foreclosure or even a short sale. In my opinion, a short sale is just another name for a foreclosure or deed in lieu of foreclosure. I would almost bet that we will see the words, “Have you ever had a foreclosure, given a deed in lieu of foreclosure or particpated in a short sale”, on a new version of the fannie mae application. And then watch what happens. I hope I am pleasantly surprised for the sake of my future business and for those who want to buy a home and who knows, maybe for me, if this crisis doesn’t come to an end soon. Can we get a true ruling from Fannie Mae, Freddie Mac or HUD? They provide the “golden rule” in lending…he who has the gold, rules!
June 22nd, 2008 at 12:39 am
Sandy those are all great points. I think that practitioners are stuck with giving the potential Seller the information currently available from Fannie Mae and let them decide. Since this stuff always changes and everyone is virtually lost (especially federal entities) there is no telling if this will change in six months of six years.
The question I have, that no one can seem to answer is this: If allowances are not made for Short Sale and Foreclosure folks, then what happens to the future mortgage industry? With a projection (and we’re almost here) that over 30% of the loans given in the past five years going into default, by the end of this year; what happens when only 2 out of three potential buyers want to buy a home in five years? Compound this issue with those who had foreclosures before this crisis and add additionally the potential for Fannie Mae to begin declining those who went through short sales, it would take the replacement of an entire generation before more than 50% of potential buyers could actually get loans.
It’s a mess and Fannie Mae and Mortgage companies not giving benevolence for the unrealistic real estate market in the future would do no more than harm themselves.
June 22nd, 2008 at 12:02 pm
Matthew, what has happened to personal responsiblity? Oh wait, when greed and fear take precedence, personal responsibility goes out the window. One of the reasons we have federal mortgage lending guidelines, is so big brother can protect me from myself and maybe more importantly protect the rest of you who are personally responsible for your actions AND take that responsibility seriously. I am responsible for my actions, whether it was intentional or accidental and will try to do the next right thing to correct the mistakes I have made. I have had to do A LOT of corrections in the past year, to get my “house” in order, and it still may not be enough. But, I have to do everything I can possible to meet my obligations. It is sometimes very painful for me to do the next right thing. I don’t want to go through the pain. I want to take the easy way out - give up and blame others or make others “pay”. I constantly hear, “It’s the mortgage companies’ fault for giving me a bad loan”. “I was told I could refinance”, blah blah blah. Why should they give benevolence…they didn’t force me to sign the papers. I have to get over it, grow up and find a way. I have come to learn that the pain I will feel to do the next right thing is short lived. I walk through the pain and when I do, I am constantly amazed as to what is waiting for me on the other side. And to answer your mind boggling question that no one can seem to answer, my friend…the answer is….you will know, when it happens.