How a Real Estate Short Sale Can Affect Your Credit Rating
The Crumbling American Dream
During 2009, real estate sales fell unbelievably. Home prices fell and instead of reaping profits in real estate, many people were left holding an empty bag. Real estate prices dropped, financing was hard to get, people lost jobs, and the market was saturated with foreclosures and short sales.
Some home owners stopped making or could not afford to pay their house payments. Job loses ruined credit history for many, and they could not refinance. Along with declining credit ratings, many were unable to work out financing alternatives with their lenders.
Basically, three options are available: sell the property before foreclosure is final, give a deed-in-lieu of foreclosure to the lender, or let the property go to foreclosure. Sometimes, if the house is worth less than the outstanding mortgage balance, buyers and investors can negotiate with a lender about short sales before the property foreclosure is complete.
Short Sale Basics:
Short sales come about by the lender agreeing to accept less than the amount owed on the home because the property does not have enough equity to sell and pay the costs of a sale. However, not all lenders will negotiate on a short sale.
For instance, home owners cannot just decide of offer their property on a short sale. Lenders wouldn't consider a short sale if payments were current, but because of the market turmoil, that has changed. Usually, lenders will be agreeable to negotiations if home payments are in arrears. But, if there are cash assets, sellers must realize that lenders might tap into those accounts.
A short sale, usually listed through MLS, involves advertising the home for sale. Real estate agents might hold open houses, and bring potential buyers to view the home, and owners can be subjected to many low ball offers. All in all, a seller's life is disrupted by needing to leave the premises when an agent calls with an appointment, and having strangers wander through their homes and among their possessions, in hopes of selling the home.
Many sellers question if a short sale is less damaging to credit rating than foreclosure. Depending on state laws, while in foreclosure, a seller can possibly stay in the property, rent free, for four months to a year before being evicted. However, this one fact does not mean foreclosure is better than a short sale.
How a Short Sale Affects Credit Ratings:
Sellers take a big hit on their credit reports by going through foreclosure, or handing the lender a deed-in-lieu of foreclosure, providing they are more than 30 days behind in payments. Examples of the points that will be lost on a FICO score are:
Foreclosure or Deed-in-Lieu of Foreclosure:
Credit rating is affected equally by both of these solutions. Depending on the condition of the seller's credit, they can expect to take a hit of 200 to 300 points on their credit rating. Example: If a seller's FICO score was 650 before foreclosure, it might go as low as 350.
Short Sale Effects:
Providing the payments are more than two months overdue, a short sale will affect a seller's credit report the same as a foreclosure. The credit report will indicate a pre-foreclosure status, and the result can be a 200 to 300 point loss. Example: A short sale can lower a previous 700 FICO score to 400.
Can I Buy Another Home?
Foreclosure or Deed-in-Lieu of Foreclosure:
Sellers hoping to purchase another home after foreclosure will need to wait approximately 24 to 72 months, depending on their credit rating.
Depending on a FICO score, a short sale might allow the seller to secure an institutional loan for another home within two years. However, it's not likely that a person can buy again in less than two years that will offer a good interest rate. Fannie Mae guidelines require 24 months' seasoning, but this is good news for agents specializing in short sales.
Sellers can apply for a new loan, immediately, to purchase another home if the seller's payments were current, have no delinquencies in excess of 30 days, and did not agree to repay the debt relief. It's the late payments that affect credit report scores, not the short sale.
Which is Best? Foreclosure or Short Sale:
Deciding whether to let your home go through foreclosure or attempting a short sale needs to be decided carefully. Trying to save your credit score, through a short sale, might not might not be advantageous. According to the 'Score Factor Code #22,' delinquent borrower's receive no credit score advantage between a short sale over a foreclosure.
However, it appears less credit report damages follow a short sale, involving late payments, than damages from foreclosures. People with credit delinquencies might be able to buy another home within a period of 2 years, versus the 5-7 years from foreclosures.
Foreclosure and Short Sale Taxes
And, then along comes the IRS! Transferring the title to your home voluntarily (warranty deed or grant deed), or involuntarily (foreclosure), makes no difference in the eyes of the IRS. As far as they're concerned, you sold your home, and may be taxed. Selling your home at a loss, on a short sale, or through foreclosure, makes you liable to be facing taxes.
Most likely, sellers who have owned their property for a long time will, likely, gain on the sale.
However, people who have owned their property for a scant two years, will, no doubt, incur a loss. These sellers will realize losses because of real estate brokerage expenses and lawyers. And, sellers will not be allowed to deduct the losses. To the IRS, it makes no difference whether sellers were forced to sell because of job loss or change, or health reasons.
Many situations can cause people to lose a home, but signing away ownership that can destroy credit, and strips an owner of dignity is one of the most difficult. A short sale is one alternative to bankruptcy or foreclosure.
If a lender agrees to do a short sale, that lender agrees to accept less than the amount owed on the property. Not all lenders will allow or accept short sales, especially if foreclosure would mean more financial sense. Additionally, not every seller or property meets the short sale qualifications.
Requirements vary from state to state, and borrower's are subjected to submit various documentation, but the following should portray a good idea of what to expect.
Be prepared to make many phone calls before you get connected with the person who is responsible for short sales. You want to speak to the supervisor (the one capable of making a decision), not the real estate short sale person, or work out liaison.
Compose and submit a letter of authorization to your lender. This will give the lender permission to speak with interested parties about your loan. Some things that need to be included in the letter are:
Your name and the current date
The name of your agent, and his / her contact information
Preliminary Net Worksheet to outline the sale price, what you expect to receive, unpaid loan balance(s), outstanding payments, late fees, and anticipated real estate fees. Your real estate agent should be able to provide a worksheet of this type for you.
Hardship Letter: This letter needs to be a factual story of what caused this financial bind by making a plea to the lender to accept less than full payment. The sadder, the better, but be honest. Don't expect a lender to be sympathetic to dishonesty or other seedy behavior. Additionally, the following will be needed:
Proof of Income and Assets
Copies of Bank Statements (3 months or more)
Comparative Market Analysis (your agent should be able to provide this for you)
If everything goes well, the lender might approve your short sale. It's possible to ask that your credit situation be kept from credit reporting agencies, but the lender is under no obligation to omit submitting an adverse credit information just because you ask.
A real estate short sale can help sellers needing to get out from under a mortgage, however, short sales are not always pleasant transactions.
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