Whether you foreclose, do a short sale or go through a deed in lieu of foreclosure your credit is shot. The extent to which your score falls may differ, but to any future creditor it is all the same. Not only that but when you apply for credit in a few years, its really important to not have any derogatory items on your credit report for at least 24 months prior to an application. For example lets say you do a short sale this month (June 2008) and you apply for a mortgage in June 2011. Then you should not have any derogatory items (late payments) since June 2009. Also, from the recent changes to credit guidelines it may be well after 2011 that you can even apply for a mortgage loan.
I had discussed this point in response to a visitor question back in December 2007. Recently another reader, who happens to be a very knowledge mortgage broker, left me a comment clarifying the current guidelines and how things are viewed today. I figured it would be to everyones interest to have the comments published as a post. So, below is the response from Catherine Coy to my post from last December “Will “Forgiven” Debt Affect My Credit Score?”
You’re very mistaken as to the impact of foreclosure vs. short sale vs. deed-in-lieu.
As a mortgage broker myself, I get many calls these days from consumers wondering what affect a short sale or foreclosure (or deed-in-lieu of foreclosure) will have on their credit. This is an important topic because the last real estate downturn (during the 1990s) preceded the widespread use of FICO scoring and automated underwriting systems.
Some real estate agents and short sale investors (those seeking to purchase a homeowner’s property prior to foreclosure)–and even some mortgage professionals–suggest to the distressed homeowner that a short sale isn’t as damaging to one’s credit as a foreclosure. Given the inherent conflict of interest—a real estate agent makes a commission on a short sale and doesn’t in a foreclosure—the real estate professional should proceed cautiously when counseling a seller. The practical reality is, short sale or foreclosure, one’s credit will suck either way.
Many mistakenly believe that a derogatory public record such as foreclosure is somehow worse than petitioning the lender to accept less than owed (short sale). In the world of banking, however, lenders interpret either of these events only one way: the customer did not pay as agreed. It matters not to a lender the manner by which it suffered a loss; only that it did. Lenders go to great lengths to alert each other, by way of reporting to credit bureaus, that the defaulting homeowner is someone who, when the chips were down, didn’t honor a contract.
In fact, lately Fannie Mae and Freddie Mac took an even stronger stand against homeowners who renege on their obligation. “Seasoning” of a foreclosure or short sale is now five years.
Fannie Mae Tightens Guidelines Again
http://calculatedrisk.blogspot.com/2008/04/fannie-mae-tightens-guidelines-again.html
In the world of FICO scoring, there are three credit events that will severely sink a FICO score, and they all carry exactly the same weight. They are (1) serious delinquency, (2) derogatory public record or (3) collection filed. A homeowner in default is technically “in collection.” These events are reported to all three bureaus as “Score Factor Code #22.”
http://www.bayhouse.com/FairIsaac-NextGen-risk-factors.shtml
A foreclosure will remain on a consumer’s credit report in the “public records” section for ten years. In addition, this fact must be attested to on the loan application under “Declarations,” Section VIII, as follows:
(c) Have you had property foreclosed upon or given title or deed in lieu thereof in the last 7 years? (Y/N)
(e) Have you directly or indirectly been obligated on any loan which resulted in foreclosure, transfer of title in lieu of foreclosure, or judgment? (Y/N)
Because the term “short sale” is not expressly stated, some interpret this as meaning that a short sale is a lesser offense. The truth is, decision makers in the lending industry know that a short sale is no different than a foreclosure or deed-in-lieu. Here are two excerpts from a lender’s underwriting guidelines.
The following items are subject to individual evaluation, no matter how high the
credit score:
• Bankruptcy, foreclosure, deed-in-lieu, short sale.
• Judgments, collections, charge-offs, tax liens.
~ and ~
Foreclosure
None in past 4 years with minimum 3 active trade lines more than 24 months old, with no late payments or derogatory credit after the foreclosure.
Definition of Foreclosure: Any 120 day mortgage late within the last 24 months, any notice of default or settlement on a real estate secured trade line (short sale), any deed-in-lieu or forbearance agreements.
To the homeowner with a mortgage he can no longer afford, the decision to voluntarily vacate through a short sale or be forced out by foreclosure can be agonizing. The sterling credit reputation it may have taken a lifetime to establish is gone with a single event. Most landlords with whom I’ve spoken state that, due to the widespread credit meltdown, they would view a foreclosure as not particularly onerous—provided that all other credit obligations were met on time. A credit report riddled with “derogs” over a broad category of obligations would be viewed negatively.
For the homeowner who, if he remains in default, must eventually vacate his home, there may be an emotional advantage to avoiding the social stigma of the “F” word—foreclosure. He can tell himself and his friends, “I’ve never had a foreclosure,” but to his lender and the credit bureaus, foreclosure and short sale are exactly the same.
This article is intended not as a judgment of the motive or character of a homeowner in distress, but to present the facts so that no one is misguided. There’s no credit preservation advantage to short sale over foreclosure. The nation’s two largest mortgage investors, Fannie Mae and Freddie Mac—with certain exceptions—won’t lend again for five years. A consumer’s FICO score will take a huge hit either way until responsible credit behavior supplants the major hit of foreclosure/short sale over a period of time.
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on Jun 2nd, 2008 at 5:57 pm
A short sale provides a great way to avoid the long term negative effects of foreclosure on your credit. A mortgage company may state a negative remark on your credit, but in the long term the impact is less than a foreclosure or a bankruptcy.
on Jun 3rd, 2008 at 6:05 am
This is a great post! Sheds some bright light on the potentail damage of the short selling your home. This should be a last resort, but unfortunately since this method of selling has become such public news, many people are purposly going default on their mortgage with the intention of selling short just as a means of breaking away from an over-leveraged property.
There are many alternative ways to sell a house to avoid a foreclosure or the need to sell short. Contacting local real estate investors is a good start, they often will examine the sellers situation and help “create” a solution that works for everyone.
Great post though, Im going to send people over to check this out when they have questions about their credit risk as it relates to these flavors of foreclosure.
on Jun 3rd, 2008 at 9:12 am
“There’s no credit preservation advantage to short sale over foreclosure.”
This is a pretty strong statement in my opinion. Let me ask you, why is it that we have so many short sale listings? Are all the distressed home owners and their REALTORS® completely misguided? If there is truly no difference between a short sale and a foreclosure impacting the distressed home owners credit report then wouldn’t we conclude from it that a short sale is just an advantage to the investor and the agent involved in the transaction?
There has to be more advantages to the home owner other than averting social stigmata.
I am very curious to know what your opinion on this is.
on Jun 3rd, 2008 at 12:16 pm
Like Chris and Christoph, it is my understanding that while a short sale is going to absolutely kill your credit in the near term, particularly because approval almost requires the seller to stop paying their mortgage, and thus they get pegged with 30-, 60-, and 90- day lates, a short sale has a quicker time to credit recovery than does a foreclosure. This point isn’t touched on, but until it gets discredited (all puns intended), that’s why REALTORS should be advising their clients that a short sale, and all of the pain they entail, are better than foreclosures.
Regarding how landlords view short sales, I can attest that 75% of the tenants I’m placing these days are going through some type of short sale or foreclosure process. As a property manager, we see these tenants as perfect for the rental property, because they’ve been home owners, and are likely to actually take better care of the property than your “typical” tenant. Often, tenant prospects in this category offer to voluntarily pay a bit extra to encourage the landlord to take them on…quite frankly they don’t need to, but when someone volunteers to pay more, we happily let them.
on Jun 3rd, 2008 at 8:04 pm
Christoph,
From my experience I have had underwriters tell me that they treat short sales under the same guidelines as a foreclosures. Once there is any of these things are on your credit report, the score is pretty much meaningless. You could have a 680 or a 600 and because of your foreclosure or short sale you’ll be treated the same. This is from a few underwriters, so I can’t say how wide spread this interpretation is.
You guys have raised some very good points. I’m going to do some digging on this topic and will report back with some hard core numbers and guideline rules. Stay tuned!
on Jun 3rd, 2008 at 9:01 pm
Your information on foreclosures is very accurate, but on short sales, it really just depends on the bank giving the new loan and that borrowers individual situation. I have to agree that I think a borrower who has gone through this situation needs to wait 2 years, but the banks are not making it a rule. Some banks have. For instance I know Countrywide and Wells Fargo are now requiring borrowers who have been through a short sale to wait 2 years. But that is not every bank making that rule. I also know that FHA has no hard rule on short sales. They are still using the rules based upon if the borrower has made rent or mortgage payments current with no lates for the last 12 months. If you have a short sale seller who then comes back to you 5 months after a short sale and kept that mortgage current, then they still meet FHA guidelines. It then just comes down to if the end bank will do the loan or not. I know currently some are and some are not.
on Jul 18th, 2008 at 4:36 am
This article is very misleading. Short sales CAN be recovered from much easier than a foreclosure. Your facts are just not accurate. The bottom line is you will take a couple hundred point hit on your credit score with the short, and it will impact you for a good three years…which is a heck of a liot better that 7-10 years with foreclosure. However, the score can be brought back up within the 3 year time with some SMART secured short term financing. Anyone that doesn’t understand these credit repair strategies is only giving one side of the coin.
I know this to be fact because I did this very successfully with my first short sale back in 1994 and helped others with it since.
on Jul 20th, 2008 at 6:04 am
If I did a short sale on my property that was inusred by FHA, can I still qualify for a home loan, I found a lender that will give me a home loan “Lend America” will FHA back that home loan up.
on Jul 20th, 2008 at 6:08 am
I did a short sale on my property back in 2007 which was backed up by FHA….now that I am reading these blogs I am hearing stories that FHA will not insure me for about 3 years, however, Lend America has qualify me for a home loan ask me to go out and find a property and I wil get a loan, should I be worried about this or be happy that I am able to get a loan and feel confident that it will be back by FHA again.
on Jul 21st, 2008 at 9:17 am
Tom,
Per Fannie rules a Foreclosure only impacts you 5 years. Not 7-10 years.
on Jul 29th, 2008 at 7:17 pm
I am in the process of getting an FHA Mortgage after a short sale in 1/2008. I think the
comments above are too derogatory in view of the facts. Short sales occur (as in my
situation) because of all the foreclosures in the area (property values fell dramatically and that impacted the comps and my husband had medical problems).
Why don’t the lenders and everyone else realize this is America 2008. Why should borrowers be punished when they have paid their mortgage on time for 19 years.
on Jul 29th, 2008 at 7:35 pm
BViti,
I am sorry if you felt the comments were derogatory - they really aren’t meant to be that way. The original post was about the impact of short sales vs. foreclosure on a persons credit score and whether or not it made sense to do a short sale at all.
I am sorry to hear of your situation. I hope everything works out for you and that your husband’s health improves.
Thanks for stopping by!
on Aug 11th, 2008 at 5:40 pm
A partner and I have a note with a bank for a property purchased in the name of an LLC however the mortgage was prepared incorrectly making the mortgage invalid and the banks ability to take title if the property as collateral impossible. The bank has title lender insurance to compensate them for a title defect or loss. Is there an impact to our personal FICO score (since we signed the note personally) even if the LLC offers deed in lieu if foreclosure and the title insurer compensate the lender for a loss? Effectively we have a binding note with the bank and the lender has no collateral however in order to achieve a semi reasonable settlement they have to sue us as borrowers or agree to a settle through a combination of the LLC transferring title of the property to the bank and the insurance settlement. Does this seem correct?
on Aug 21st, 2008 at 4:48 pm
Make sure you understand the landlord tenant laws in your state and have your rental/lease agreements prepared by or reviewed by a good real estate attorney. If there has been a foreclosure, don’t pay rent to the old landlord. Rather, try to find out who now owns the building. Dave
on Sep 2nd, 2008 at 2:22 pm
Do anyone know of a company that will allow me a home loan AI have at least a 640 credit score however I am understanding that because my short sal eI went through on a FHA loan that I cannot get approve for at leaset 2 years after my sort sale, is this true,,,di anyone know how long you have to wait before applying for a FHA loan, after a short sale on a FHA loan…