This is a general overview of the benefits and drawbacks of going through a foreclosure vs. a short sale. I am neither a lawyer nor a tax consultant, you owe it to yourself to consult one to know what the effects of a foreclosure or short sale will be for you personally.
If, after you review this information, you think selling your home via a short sale may be an option, call or email me. I will answer your questions and give you a complete overview of the process so you can make the best decision for your situation.
Benefits for Foreclosure
Although going through foreclosure can be painful and embarrassing, there are benefits:No mortgage payments to make.
- No 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 really want to experience a foreclosure. Memories are made in a home, and losing it can shatter future dreams:
- The right of home ownership is striped 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, without extenuating circumstances, you will not be eligible to buy another home for 5 years.
Benefits for Short Sale
What do you get out of a short sale?
- Retain some dignity in knowing that you sold your home.
- You won’t suffer the social stigma of the “F” word: foreclosure.
- No mortgage payments to make, unless you choose to make them.
- You can meet the new owners.
- You will be eligible, under Fannie Mae guidelines, to buy another home in 2 years instead of 5 years.
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 up to 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.
How is Your Credit Affected?
Foreclosure or Deed-in-Lieu of Foreclosure
Both of these solutions affect credit the same. Sellers generally will take a hit of 200 to 300 points, depending on overall condition of credit. This means if a seller’s FICO score before foreclosure was 680, it could dip as low as 380.
The effect of a short sale (providing the sellers are more than 59 days late) on a seller’s credit report is still up for debate. It all depends on how the lender reports the short sale to the credit reporting agencies. I am of the opinion that a short sale will look better on your credit report then a foreclosure. A short sale will show that you made an effort to resolve the problem, which I believe will benefit you when applying for credit in the future.
Waiting Period Before Buying Another Home
Generally a seller who wants to buy another home after foreclosure will end up waiting about 3 to 7 years before a lender will offer any kind of interest rate that makes sense. Here is what I have found out:
Buying After a Foreclosure: The waiting period typically is 4 years up to 7 years.
Buying After a Foreclosure With Extenuating Circumstances:
The waiting period is 3 years up to 5 years.
What are documented extenuating circumstances?
Fannie Mae allows for extenuating circumstances such as:
Death (not yours, of course)
Accident Resulting in Severe Injury
Generally, extenuating circumstances are things that happen beyond your control, which dramatically affect your ability to continue making payments on your mortgage. With documented extenuating circumstances, the waiting period is less than without. Being unable to afford an increase in payment due to an interest rate increase on an adjustable-rate mortgage is not considered a circumstance beyond your control.
Buying After a Deed-in-Lieu of Foreclosure: The waiting period is 4 years up to 7 years.
Buying After a Deed-in-Lieu of Foreclosure with Extenuating Circumstances: The waiting period is 3 years up to 7 years.
New Fannie Mae guidelines now require only 24 months’ seasoning, at which time the short sale seller can apply for a new loan at a reasonable interest rate. This does vary with lenders and the length of time can be 2 – 4 years depending on the lender and how much credit rebuilding you have done.
Short Sale / Foreclosure Deficiency Judgments
The bad news is you could be subject to a deficiency judgment for the difference between the loan amount and the amount paid. In general, a trustee’s sale wipes out the right to a deficiency, except for certain junior lien holder conditions. In California, purchase money loans are not subject to deficiency judgments; however, some hard money loans, equity loans and refinances are, providing certain conditions apply.
The lender has sole discretion whether to pursue a deficiency judgment in those instances when the judgment is permitted. To determine whether a pending foreclosure or short sale is subject to a deficiency judgment, talk to a real estate lawyer.
Short Sale and the IRS
Your lender will issue a 1099 statement charging you with taxable income on the difference between the amount you owed and the net sale price that the lender was able to receive for your home. Normally, debt that is forgiven in a short sale is required to be reported as taxable income on your tax return. Historically, short sellers were required to pay income taxes on every dollar forgiven by the mortgage lenders. However, under the Emergency Economic Stabilization Act of 2008, if you short sell your principal residence between 2006 and 2012, you will not be taxed on the debt forgiven by your lender. This act has been extended numerous times. Check to make sure it is still in effect.
The lender issues the 1099 to be able to write off the amount they canceled on their taxes. You still must report the amount of debt forgiven, or canceled on Form 982 with your federal tax return. The IRS will not charge you any income tax on the canceled debt, just make sure to do your bookkeeping and file the appropriate forms.
Again I encourage you to seek legal and tax advice before making this decision.
If you would like to talk to me about selling your home via short sale
call me directly at 760.476.9560 or send an email via my contact page