Foreclosure versus Short Sale

In these difficult economic times, I am commonly asked whether it would be better to have a short sale or a foreclosure on ones credit report. The answer is complicated and has lot of moving parts.  A short sale shows up on your credit report as a “derogatory report”; however, it will usually show up on your report as “short sale” or “settled for less then the full balance”. Of course, this will reflect negatively on your credit report. If you have not had any late pays prior to the short sale, your score will likely drop somewhere between 75 and 120 points. Each person’s credit score will vary depending on several factors, such as how much credit you have, how much of your credit facility you are currently using, and how long you have had certain types of credit.  You will unlikely be able to obtain a home loan for a couple years. As a general rule, if one has a foreclosure on a credit report, then the waiting period is up to 7 years. The period may be reduced to 3 years if you fit into one of the extenuating circumstances. You should speak with a mortgage broker to see which of the extenuating circumstances may help you reduce the hold period to 3 years. In fact, my best is advice is to speak with more than one mortgage lender so that you may educate yourself about various lender requirements. Please know that different lenders may vary their interpretation of the underwriting requirements, and private lenders may adopt their own underwriting requirements.

Below is a “cheat sheet” from one lender to help you understand this. However, down the road, when you are able to obtain a home loan, a lender may very well look at a short sale as you did not walk away from the property and tried to do the “right” thing. To repeat, if you have acceptable extenuating circumstances, the hold period could be lots shorter. There are lots of extenuating circumstances; however, the death of spouse and catastrophic medical conditions are two commonly accepted circumstances that may shorten the hold period. Further, and very importantly, this all assumes you have worked hard on your credit and have a good credit score. Whether you have a short sale or a foreclosure, repairing your credit is paramount. Here are some current underwriting guidelines:

Foreclosure     If the home was returned to the bank without homeowner participation,the hold period up to 7 years, unless there are some acceptable extenuating circumstances (you will need to talk with a mortgage broker about what extenuating circumstances are acceptable). If you have acceptable extenuating circumstances, the hold period can be reduced to 3 years.

If the homeowner returned the home to the lender with a deed-in-lieu of foreclosure, the hold period is generally 3 years, unless there are acceptable extenuating circumstances.

 Short Sale The homeowner participated in the sale of the home, the hold period is up to 4 years with a 10% down payment and as short as 2 years with a 20% down payment. The 4-year hold period can be reduced with appropriate extenuating circumstances to 3 years and, in some cases to 2 years.

If you choose to take the short sale route and have a 1^st and 2^nd on the property, you should attempt to negotiate a full release from both lien holders. With full releases, we sometimes see the language such as “non-deficiency” or “lender waives deficiency”.  If you have a full release or no possibility of a deficiency, the lender cannot come after you for any amounts they may have been owed. This is absolutely critical. Otherwise, you could find yourself with a deficiency collection and/or deficiency judgment. In order to move forward with a home loan down the road, any deficiencies that were not properly negotiated and/or forgiven will have to be paid or settled before you will be able to obtain a home loan.  As with anything this complicated, you should speak with an attorney before agreeing to a short sale.