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Will a Short Sale Damage Your Credit Less Than a Foreclosure?
As real estate values continue to sag, pushing many home owners toward foreclosure, one question surfaces more than any other. Will a short-sale damage your credit less than a foreclosure?
REWIND
I wrote a couple of articles awhile back entitled, Short Sales vs. ForeclosuresYour Credit Will Suck Either Way and Short Sales and Loan Prospector: A Response From Freddie Mac. At the time–nearly a year ago–my preliminary investigation suggested that short sales and foreclosures would have exactly the same effect on credit. But back then, this issue was just reclaiming the spotlight, and no one had really given it much thought. You see, it has been 10 years since we’ve really seen this problem.
Those articles are still garnering comments, and I’ve been getting daily phone calls and emails from all over the country from people facing foreclosure. So recently I reopened the investigation. And although the issue is far from clear, my conviction is the same. As far as your next mortgage is concerned, a short sale won’t leave your credit in better shape than a foreclosure. And it could leave you worse off from a tax standpoint.
NOT EVERYONE AGREES
Now I need to acknowledge the disagreement out there. Speculation is rampant, but a lot of it is groundless. There are people predicting the number of points each type of foreclosure will move your scores, a claim my credit reporting agency called “asinine.” Real estate agents seem more prone to recommending short sales, though most of the agents I know are very cautious about this. One Realtor/lender wrote,
there are ways around the issues you have pointed out. First, the NOD does not show up on a client’s credit report, just the late payments (30, 60, 90). Second, if the lender issues a 1099-C for the amount of the loss, then the lender, by law, has to report the credit report as “paid in full”. The lender is regulated by the OTS and has to issue the 1099-C if they want to keep their books in order and not have issues with the OTS. Also, if they accept $60K on a $100K note and send the client a 1099-C for $40K, they must show “paid in full” on credit. You can not report the $40K as income to the borrower and accept the $60K without clearing up credit. Most lender’s won’t correct this unless you bring it their attention. The lenders see it as the final “screw you” to the client on the way out the door.
He may be right, but I have been unable to find the law referenced. In a way the argument makes sense. But then, even if the lender can write off the loss, they have still not really been paid in full, have they? That alone makes me skeptical.
In practice, lenders have subtle ways of indicating to the credit bureaus that they got stiffed. They typically place a small comment in the notes section of mortgage trade-line that says settled or settled for less. Or they can put a “9″ in the code section that shows month by month payment history. Either of those is enough to tip off a lender or the credit bureau.
ASSUMING YOU CAN FOOL THE CREDIT BUREAUS
But let’s assume for a second that the gentleman is right about the law and that as a result, the credit bureaus cannot see any indication of the short sale. And let’s even assume that the borrower was current on payments prior to the short sale and has a perfect payment history and high Ficos.
That might help with other borrowing, but when that person applies for another mortgage, there are three questions on the mortgage loan application that you still face:
- Have you had property foreclosed upon or given title or deed in lieu thereof in the last 7 years?
- Have you been obligated on any loan resulted in foreclosure, transfer of title in lieu of foreclsoure, or judgement?
- Are you presently delinquent or in default on any Federal debt or any other loan, mortgage, financial obligation bond, or loan guarantee?
Now, you may be thinking what I was thinking: “these questions don’t specifically mention short sales.” In fact, Fannie/Freddie guidelines refer only to foreclosures and deeds in lieu–an oversight I’m sure someone has noticed by now. So for now, it wouldn’t be lying to answer “no” to those questions then, would it?
MAY I SEE YOUR ID PLEASE?
Well it might not be lying, but it would be omitting a material fact that might affect a lender’s decision to make you another loan. And whether you omit or misrepresenting an important fact, you are committing loan fraud. Ask any Realtor what their Errors and Omissions insurance is for.
It’s a little like not being “carded” at the bar. Just because they served you doesn’t make it legal.
Join the discussion or share your short sale experience below.
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November 29th, 2007 at 5:05 pm
I called a short sale company and they told me I can’t be current on my mortgate before asking the lender for approval on a short sale. I’m current but they does not mean I can afford it. It took me a year to work something out with my lender now I can see the number are too tight. Could I talk directly with the lender and ask them not to post my mortgage lates then I will do a short sale. I hate to just stop paying the mortgage company because the short sale company say’s I have no other choice. It seems like I said in my last post, no matter what you do the mortgage industry is going to ding you one way or the other.
November 30th, 2007 at 11:48 am
Kind of Catch-22 isn’t it Tom? The lenders won’t usually talk to you unless you’ve proven your hardship by defaulting on your payments. Once you do that, you’ve already started damaging your credit.
I don’t know if that’s a “screw you” or just a stall tactic on the part of the lenders. There are certainly other ways they can tell if you’re unable to make your payments.
What I can tell you is that there is increasing pressure on lenders to work pro-actively with homeowners. Lenders who have previously set up counseling centers (sounds good) but then dispensed worthless and stupid advise like “get a roommate”, or “go find a 2nd job” are being ripped now in the press. Check out http://www.Countrywidehomeloansucks.com . With enough of this sentiment, lenders will come around. Hang on if you can.
November 30th, 2007 at 7:23 pm
[...] The media is beating us about the head on a daily basis about the rising number of foreclosures across the country and how they will effect the housing market. Marc over at Lending Clarity has an excellent post on the difference in a short sale vs. a foreclosure on your credit report. [...]
December 1st, 2007 at 7:59 am
Just had what I thought was an update from the national sales director at a major credit reporting firm.
I had forwarded a flyer from a title company quoting another local lender and predicting only an 80-100 point drop in Fico scores from a short sales vs. a 200-250 point drop from a foreclosures.
At first she said it was true, citing as evidence “industry statistics”. Later she indicated that it was mainly anecdotal evidence from home owners currently going through the process. What?
It’s hard to imagine that the there is enough data to yet draw that conclusion. And I suspect that there are other factors at work, like whether the homeowner has been current on payments up to the event.
Most people that I speak with who are considering a short sale are frustrated to contact the lender and be told that they must first default on a payment before the lender will talk. In other words, they are current on their mortgage at the time.
Once people decide to go to foreclosure, most have given up on other options and simply stop making payments. A series of late payments ensues, followed eventually by a Notice of Default. That could certainly be harder on your scores.
In the end, Fico scores aside, once a new lender learns you’ve had a short sale, don’t count on getting a mortgage for at least 2 years, and then it will depend on how quickly your scores bounce back.
December 11th, 2007 at 11:27 am
Since the credit will be dinged anyway, might as well go foreclosure since you will not get the 1099. Is there any talk to change the tax implication?
I am helping a friend who needs to make the decision, in the end it’s her decision, but short sale seem like it will drag out for a long time.
How is the credit hit affecting people who then have to go find a rental?
December 13th, 2007 at 6:04 pm
Stellaaa, I have clients whose attorney have recommended just that: let it go to foreclosure. That at least may mitigate some of the tax liability.
There is, I think, a bill that has been approved by the House and is before the Senate or may even be on the Pres’s desk for signature that waives the tax liability for debt relief. Of course, insolvency will qualify you for a waiver from the IRS for any tax associated with debt relief. I’m not sure how the state with income taxes feel about that.
Short sales have a window. Typically, if the sale cannot be consummated in a reasonable period of time, the lender forecloses anyway.
Your question about credit scores and renting is a good one. The answer may lie in the landlord’s perception of the risk. If I were considering leasing to someone with a short sale, I would look harder at credit prior to the short sale, at the borrower’s job and income, and at how the problem came to be.
April 18th, 2008 at 4:53 pm
[...] And what about the so called “rate freeze”? Because of a few short sale posts here at Lending Clarity, homeowners from across the country contact me every day asking for advice because they can’t get their lenders to help them. These efforts on the part of lenders so far are voluntary, so they can easily add their names to the media’s good-guy list without actually doing a thing to help anyone. And that seems to be the reality so far. [...]