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Foreclosure, Deed in Lieu of Foreclosure, Short Sale, and Loan Modifications can all have long-lasting impact on an individual’s ability to obtain credit. Homeowners need to get the facts before making critical decisions that will impact their lives for many years to come.Remember to check with you accountant, CPA and/or attorney prior to making any decisions that might affect your long-term financial standing.
In general, when it comes to foreclosure and how it affects the ability to obtain credit in the future, there are multiple points of extremely negative impact. Deficiency judgments for the amount not collected by the lender in the foreclosure sale can end up on a borrower’s credit report as a derogatory mark. Additionally, there is a high risk that the borrower will be hit with a substantial tax penalty which can result in a tax lien which also appears on the credit report. As a general rule, other than a bankruptcy, foreclosure is the least desirable of all of the options available when a borrower is upside down in a home mortgage.
Whether you should do a short sale, loan modification, deed in lieu of foreclosure or let the home go to foreclosure depends on several factors. While for some homeowners, it is easier to throw up your hands and let the bank take your home, that might not be the wisest thing to do.Here is a breakdown of things to consider when deciding amongst these options.
Short Sales
Benefits of a Short Sale
Here are a few benefits for doing a short sale that may not have occurred to you:
- You may sleep better at night knowing who is buying your home.
- Retain dignity knowing your sold your home and spare yourself the social stigma of the "F" word, foreclosure.
- Contrary to popular belief, you can be current on your payments and still effect a short sale.
- Your home sale will be handled like any other home sale.
- No mortgage payments to make, unless you choose to make them.
- You will be eligible, under Fannie Mae guidelines, to buy another home in 2 years instead of 5 to 7 years.
- If your credit report does not reflect a 60-day+ late pay, under Fannie Mae guidelines, you will be eligible to buy another home immediately.
Drawbacks to a Short Sale
- You may experience some of the same drawbacks as a foreclosure, but they might seem less intense.
- Waiting for the bank to respond to an offer is frustrating.
- The bank will want to examine personal records such as tax returns, bank accounts, assets and liabilities, in addition to asking for a hardship letter from you.
- Accommodating buyers will mean keeping your home in spotless condition for weeks or months until an offer is received and putting up with traffic through your home.
- There is no assurance the bank will accept a short sale offer.
- The derogatory credit will remain on your credit report for 7 years.
- For many sellers, though, the chance to buy another home in two years is the real motivation to do a short sale. Good credit behavior can supplant bad credit after two years, even though the derogatory will remain.
Affects on Credit After a Short Sale
A short sale is not a derogatory mark on your credit because credit bureaus do not show the word "short sale" on your credit report. It may say "pay as agreed" or "paid as less than agreed," among other categories A short sale, on the other hand, can adversely affect a score by 120 to 130 points, The point drop is typically due to being in default, that is behind on your payments.
Credit Reporting
When you short sale a home, the lender may report it in one of several ways. It can report it as if it were a foreclosure, which is the worst outcome. While this may seem unfair, it does happen. A lender can also report it as "paid-settled," “paid as agreed”, “paid as negotiated” or “settled.The bank may also report your account as "unrated," which is similar to the "paid-settled" category. Since you are essentially doing the bank a favor by offering to sell the property, albeit at a loss, to keep the bank from a costly foreclosure, you can try to negotiate beforehand with the bank to report it as "paid-settled" or "unrated."
Credit Score
A short sale will damage your credit score. How a short sale will affect your credit depends upon a number of factors.
- How many months was the seller late on their mortgage before the short sale closed?
- What language did the lender use when they issued the short sale approval? (e.g. debt satisfied versus paid less than owed).
- What did the listing agent negotiate with the lender’s negotiator?
- How the bank reports the short sale to the credit bureaus
Many lenders only accept short sale offers from borrowers who are already behind on payments, because it shows that they are at risk of foreclosure, so some borrowers may have let themselves fall behind on purpose so they could do a short sale. Other borrowers may simply have fallen behind due to financial hardship.
If you were never late and the bank reported the short sale as "paid-settled," expect only a ding to your credit score of about 30-80 points. However, if you were late on your payments or the short sale was reported as a foreclosure toe the credit bureaus, it may cost you up to 200 points on your score. A short sale’s effect on your credit score can last from 12-18 months.
Buying Again After a Short Sale
If your payments have never fallen behind 30 days late and the lender does not require that you pay back the loan, Fannie Mae guidelines may allow you to buy another home immediately. The wait for an FHA loan is 3 years.
If your payments are in arrears yet a short sale is granted by your lender, you may qualify to buy another home with a Fannie-Mae backed mortgage within two years, regardless of whether the home is your primary residence.
Deficiency Judgments After a Short Sale
Some states allow a lender to enter a deficiency judgment against you if the amount you sold your home for was less than was owed on the loan; other states do not allow deficiency judgments.NC has an anti deficiency statute that protects homeowners in most instances from having a deficiency judgment entered against them.
The new HAFA program requires borrowers to be fully released from future liability for the first mortgage debt and, if the subordinate lien holders receive an incentive under HAFA, those debts as well (no cash contribution, promissory note or deficiency judgment is allowed.
Loan Application Questions After a Short Sale
Loan applications do not ask questions about a short sale. You may report that you sold your home.
Length of Time to Move After a Short Sale
If you've had a foreclosure notice filed, you may be able to postpone that action while the bank considers your short sale. The wait for short sale approval can be from 2 to 3 months, or even up to a year or longer.
Taxation After a Short Sale
A personal residence is exempt from mortgage debt relief until the end of 2012 on a federal level. Some states will still tax you unless you qualify for an exemption. An investor is not exempt from the Mortgage Forgiveness Debt Relief Act of 2007 of subject to certain conditions.Note:NC state law does not conform to the federal Mortgage Forgiveness Debt Relief Act of 2007, therefore, mortgage debt that was not forgiven / canceled by the lender is considered to be personal income by the state and is taxable.
Foreclosure
Benefits of Foreclosure
Although going through foreclosure is often painful and embarrassing for sellers, there are benefits:
- No more mortgage payments to make.
- Foreclosure proceedings take months to conclude.
- The home is still yours until the foreclosure is final.
- No strangers are traipsing through your home.
- Banks sometimes give cash for keys after the public sale.
Drawbacks to Foreclosure
Few people, apart from the sellers who choose to buy and bail, really want to experience a foreclosure. Memories are made in a home, and losing it can shatter future dreams. Here are other drawbacks to foreclosures:
- The right of home ownership is stripped away.
- Homeowners return to the rental market as a renter.
- The bank may post a Notice of Public Sale on your front door.
- Your credit takes a nose dive, and a foreclosure will remain on your credit report for 10 years.
- Under Fannie Mae guidelines, if a homeowner lost their primary residence to foreclosure, you will not be eligible to buy another home with a Fannie Mae backed mortgage for 5 years.
- An investor who loses a non-primary residence to foreclosure is ineligible for a Fannie Mae backed mortgage, FHA, VA or conventional mortgage for a period of 7 years.
- Fannie Mae recently announced that they will make people who can make their payments and who choose to do a strategic default wait 7 years before they are eligible for a Fannie Mae loan. Furthermore, Fannie Mae stated that they will pursue deficiency judgments in states that allow this by law.
Affects on Credit After a Foreclosure
Credit Reporting
A foreclosure can be reported as a Foreclosure or Repossession and carries the most negative penalty on a credit score just under a public record (i.e. bankruptcy, tax lien, or judgment.) There is a misconception that foreclosures are considered public records to the scoring system. However, they are not. Although there is a Public Notice Record on file once a foreclosure is started, this record is completely different than a credit report public record.
Unless a foreclosure becomes a public record, such as a judgment, it can only be reported on a credit report for 7½ years from the date of the first late pay that led to foreclosure. Many consumers and lenders believe that it is 7 years from the completion date of the foreclosure process, but that is inaccurate. A foreclosure falls under the same rules as a collection, charge-off, or other similar action.
Credit Score
A foreclosure can drop credit scores from 200-400 points (this includes points already lost due to delinquent payments). The homeowner’s credit score will often be impacted for a period of 3 years.
The difference in point loss depends on how many points someone has to lose in the payment history factor of his or her credit report. Thus if someone has a 750 credit score and they opt to foreclose, their score could drop up to 250 points. However, if someone has a 600 credit score, they may only lose 100 points for the same derogatory.
If a deficiency judgment or tax lien is filed in connection with a foreclosure, credit scores can drop an additional 100 points.
Employers do have the right to check the credit regularly of all employees. Many employers are now requiring credit checks on all job applicants. A foreclosure could challenge employment.
Foreclosure can have a challenging affect on your security clearance. If someone has a foreclosure and is a police officer, in the military CIA or other position that requires a security clearance, that clearance could be revoked and the position terminated!
Buying Again After a Foreclosure
Under Fannie Mae guidelines, if a homeowner lost their primary residence to foreclosure, you will not be eligible to buy another home with a Fannie Mae backed mortgage for 5 years.
However, if extenuating circumstances caused the borrower to enter into a foreclosure proceeding, such as the sub prime mortgage crisis fallout, loss of employment or a severe medical crisis, the waiting period, if approved, is 3 years from the date the foreclosure proceeding is completed.
You May Have Extenuating Circumstances & Not Know It!
In most cases, homeowners who are facing mortgage default will at some point want to purchase a new home, however, there are specific waiting periods put into place to make sure that consumers have enough time to rebuild and re-established good credit. The good news is that for consumers who are being forced into mortgage default due to extenuating circumstances, those waiting periods are reduced.
Here is the definition of Extenuating Circumstances as it appears in the 2010 Fannie Mae & Freddie Mac Guidelines:
Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.
If a borrower claims that derogatory information is the result of extenuating circumstances, the lender must substantiate the borrower’s claim. Examples of documentation that can be used to support extenuating circumstances include documents that confirm the event (such as a copy of a divorce decree, medical reports or bills, notice of job layoff, job severance papers, etc.) and documents that illustrate factors that contributed to the borrower’s inability to resolve the problems that resulted from the event (such as a copy of insurance papers or claim settlements, property listing agreements, lease agreements, tax returns (covering the periods prior to, during, and after a loss of employment), etc.).
The lender must obtain a letter from the borrower explaining the relevance of the documentation. The letter must support the claims of extenuating circumstances, confirm the nature of the event that led to the bankruptcy or foreclosure-related action, and illustrate the borrower had no reasonable options other than to default on their financial obligations.
With certain restrictions, you may be eligible to buy another home in 5 years if the home was your primary residence. Without restrictions, the wait is 7 years.
If you are an investor and do not occupy the home, the wait to buy with a Fannie Mae insured loan is 7 years.
Deficiency Judgments After a Foreclosure
Some states allow a lender to enter a deficiency judgment against you if the amount you sold your home for was less than was owed on the loan; other states do not allow deficiency judgments.NC has an anti deficiency statute that protects homeowners in most instances from having a deficiency judgment entered against them.
The new HAFA program requires borrowers to be fully released from future liability for the first mortgage debt and, if the subordinate lien holders receive an incentive under HAFA, those debts as well (no cash contribution, promissory note or deficiency judgment is allowed.
Loan Application Questions After a Foreclosure
You are required to answer ‘YES’ to question C in Section VIII of the of the standard 1003 form that asks: "Have you ever had a property foreclosed upon or given a deed-in-lieu thereof in the past 7 years." If the bank sees you have had a foreclosure, your loan most likely will be denied. If you lie, you may be subject to investigation by the FBI for mortgage fraud.If you are able to get a loan, this will affect the loan rates you will be able to get.
Length of Time to Move After a Foreclosure
Unless prior arrangements have been made, the bank may want you to immediately vacate the property and can commence eviction proceedings.
Taxation After a Foreclosure
A personal residence is exempt from mortgage debt relief until the end of 2012 on a federal level. Some states will still tax you unless you qualify for an exemption. An investor is not exempt from the Mortgage Forgiveness Debt Relief Actof 2007 of subject to certain conditions.Note:NC state law does not conform to the federal Mortgage Forgiveness Debt Relief Act of 2007, therefore, mortgage debt that was not forgiven / canceled by the lender is considered to be personal income by the state and is taxable.
Deed in Lieu of Foreclosure
How Does a Deed in Lieu Of Foreclosure Affect the Borrower’s Credit?
Most lenders report a deed in lieu of foreclosure as a foreclosure, so the credit scores will carry the same serious effect as if it were an actual foreclosure. However, borrowers can negotiate with the lender to report it differently in return for turning over the deed and avoiding foreclosure costs.
Many lenders will say that they cannot change the reporting status, but as you now realize, they can. Here are the credit reporting options in preferred order:
- Paid As Agreed - Credit scores will have already dropped over 100 points due to default in payments; however, if reported as Paid As Agreed, the borrower will be able to purchase another home in a shorter time period.
- Paid Settlement - Credit scores could drop up to 100 points in addition to the points already lost for delinquent payments.
- Foreclosure - See above.
How Long Before You Can Buy Another Home After Deed In Lieu Of Foreclosure?
The current guidelines from Fannie Mae & Freddie Mac state that the waiting period for a Deed in Lieu of Foreclosure is 4 years from the date the proceeding is completed.
If there are extenuating circumstances that caused the borrower to have to enter into a Deed In Lieu of Foreclosure proceeding, the waiting period is 2 years from the date the proceeding is completed.
Loan Modification
A loan modification is when the lender agrees to modify a part or all of the terms of the original mortgage loan agreement. This existing note is modified and remains in place. Changes to the agreement can include: extending the term of the loan, changing the monthly payments, and changing the interest rate to make the loan more affordable and to help the homeowner avoid foreclosure or bankruptcy.
Loan modifications have become extremely common. So much so that a backlog of cases has forced lenders to prioritize their caseloads. This largely means that many homeowners are being forced into default to get their attention. This is unfortunate, because one 30-day late pay can cause a 50-80 point drop in credit scores. The good news is that borrowers who choose this option vs. foreclosure or bankruptcy, show that they are exhausting every effort to pay the loan, and the effort will show in your credit scores and history.
How Does A Loan Modification Affect the Borrower’s Credit?
Lenders use special codes to report consumer account information to the credit bureaus. When the loan modification program was announced, lenders used an existing code, called AC, to signal that their clients were participating in a loan modification program. The problem for those borrowers, was the fact that the AC code indicates that the consumer has only made a partial payment, or has entered into a settlement agreement, paying less than the amount due. Why would lenders use this code? Because there is no code for a loan modification, and the AC code is the closest fit.
Here’s the good news, a new code was developed in November 2009. It is called a CN code, and it will indicate a loan modified under a federal government plan — which should eventually have no impact on credit scores.
Here’s the temporary bad news — for the time being, the FICO scoring model does not consider the new CN code. Before a change of this magnitude can be made to the FICO model, FICO must concludes that the code in a credit file is accurately predictive of the consumer’s behavior. That means testing, case studies and research, which will hopefully be completed by year end.
Note: The new CN code will not eliminate late pays that were made during the loan modification process. So Borrowers who pay late will still see a significant drop to their credit scores. And, regarding consumers who have already been reported under the AC code, at the moment, there is no retroactive guidelines, however, most experts believe that there will be soon.
Bottom line, if you are a homeowner who is in the process of a loan modification now, or a homeowner who has already gone through the loan modification process, you should ask your lender to report the account under the CN code now, that way the new code takes effect, your scores should go up immediately.
In Conclusion
My advice to any homeowner on the verge of foreclosure is, first and foremost, find out what options are available. Do the research. Consult the experts. Gather as much information as possible, and weigh the pros and cons. What may seem to be the best answer right now may also have a serious impact for many years to come, so make an educated decision.
What is an SFR?
The complex details involved with short sales and foreclosures are unique calls for specialized expertise.Contact an agent such as myself that has earned the Short Sale and Foreclosure Resource (SFR) Certification through the National Association of Realtors and who is committed to helping you understand your options so you can make the best possible decisions for you and your family.
If you are in a situation where your home is “underwater” due to falling home prices, you are unable to make your current mortgage payments and you are considering pursuing options such as a short sale, deed in lieu of foreclosure, strategic default or even foreclosure, there could be drawbacks that I, as a real estate agent, cannot advise you on.For your protection, I suggest that all borrowers:
- Obtain legal advice from a competent real estate lawyer regarding deficiency judgments
- Call an accountant or CPA to discuss short sale and foreclosure tax ramifications
Except for certain conditions pursuant to the Mortgage Forgiveness Debt Relief Act of 2007, be aware the I.R.S. could consider debt forgiveness as income, and there is no guarantee that a lender who accepts a short sale or foreclosure will not legally pursue a borrower for the difference between the amount owed and the amount paid. In some states, this amount is known as a deficiency. A lawyer can determine whether your loan qualifies for a deficiency judgment or claim.
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