The Top 3 Things you should consider if faced with a Short Sale vs. Foreclosure decision…
FICO IMPACT IN A SHORT SALE
First, there is no such thing as having a “short sale” on a credit report. Instead, there will be an item on the credit report stating something to the effect of “Debt settled for less than what was owed.” This, in itself, is a minor blemish on one’s credit.
The greater impact in a short sale comes from the late payments report by the lender(s) for each month the borrower misses a payment. Therefore, the quicker the short sale, the fewer missed payments and the less degradation to one’s credit.
In terms of credit after a short sale is complete, clients have reported that within six or nine months, their credit scores were back to or near the highest they ever had.
The reason for this is:
- Their personal balance sheets improved immensely once the debt from their home was removed
- They kept current on all their other obligations, and
- They did not max out credit cards.
The rule of thumb is that if the seller of a short sale conservatively manages their other financial matters, the short sale will have a minimal impact on credit.
With regard to how long the reporting stays on one’s credit, your estimate of two to three years is accurate. Generally, late payments have less of an impact after two years (not considered) and it is possible to have all reporting of the short sale expunged after three years.
FICO IMPACT OF A FORECLOSURE
If the homeowner decides to allow his or her home to go back to the bank, the immediate impact could be (and probably will be) quite severe. Credit scores will probably drop by hundreds of points, even below the reduced scores they have already experienced because of missed payments. The person’s credit scores will continue to reflect the foreclosure for about the next seven years. Please understand the difference here between “credit scores” (generally referred to as one’s FICO) and a “credit report.” Although the person’s credit scores should rebound after seven years or so(assuming all other financial matters are managed well), the person’s “credit report” will always reflect the foreclosure. This does not go away over time. This is a very important point because many employers (especially ones having to do with security clearance) have policies that prohibit employing anyone with a foreclosure or bankruptcy on their record.
A fellow Surterre agent actually had a client, who decided not to short sale their home because they figured they could stay in the property longer by delaying the foreclosure, frantically she called once the foreclosure took place because she was immediately dismissed from her job of 11 years (a large insurance firm) because of the foreclosure and her company’s policy.
DEFICIENCY JUDGMENTS
Something else few people consider is if there is a second lien holder on the property and it is foreclosed, that lender has the legal right to pursue the borrower for the full amount AND issue a 1099, which is counted as regular income. Say the borrower has a second on their home (could be a home equity line of credit) for $250,000. If the first forecloses, the second loses all their money. Their recourse is to pursue the borrower (which they will) and let the IRS know they defaulted on a quarter of a million dollars, which the IRS now wants their share of. This borrower is not only going to have to deal with the collection agency assigned to this, but also the IRS.
In a short sale, law makers (ESPECIALLY in California) have made it easy on the borrowers or choose a short sale over a foreclosure (and the banks prefer it, as well). If it is a residential property of four units or less (even if it’s an income property) there is almost never going to be a deficiency judgment against borrower (unless there was fraud), even if there is a second, third or fourth lien. This became law on July 15, 2011 with SB458. Also, if it is the borrower’s primary residence, and the loss is less than $1 million, there will probably be no income tax issues, either (neither State or Federal), although we ALWAYS suggest they speak to their tax advisers.
Finally, people simply feel better about “selling” their home as opposed to being evicted. It is better for the neighborhood, for their well-being and in just about every other way conceivable.
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