Short-Sale vs. Foreclosure???
This is the hot topic right now and for some reason many people are still finding it confusing; most likely due to the mis-information being spread about the topic. With the current state of the mortgage market, consumers that are trying to do the right thing and sell their homes to avoid foreclosure are in a tough spot. If they can't sell their home for the asking price and they can't lower the price because it won't be enough to cover the loan amount - a short sale or a deed in lieu of foreclosure may be their answer. A deed in lieu of foreclosure is when the mortgage holder agrees to simply move out without forcing the lender to legally remove them through a foreclosure proceeding and has the same impact on the credit score as a short sale.
So what exactly is a short sale? Basically, a short sale is when the mortgage lender agrees to accept less than the full loan amount to pay off the loan. Here's how it works: If they owe $100,000 on their home and someone offers them $75,000, their mortgage lender could agree to accept the offer and forgive the $25,000 difference. This difference is called a deficiency balance and the mortgage lender agrees to take the loss. In the past, the homeowner was taxed on the deficiency balance but with the recent mortgage crisis, legislation signed by President George Bush has been put in place that excludes short sale deficiency balances as taxable income.
Short sales have always been around but have become much more common in today's mortgage market. The good news is that short sales offer hope to consumers that need to get out from under a mortgage that they can no longer afford. While a short sale is definitely a good move when a buyer for the full loan amount can't be found, the bad news is that their credit scores could suffer and take a huge hit because of the short sale.
Here's where the confusion begins...
A short sale is a settlement due to the fact that they didn't fully pay the loan as agreed in the original terms or contract for the loan yet the balance is now $0. When there is a short sale, the mortgage lender will report the account as "settled for less than the full loan amount." The exact terminology may vary slightly but they all mean the same
thing: even though the loan is reported with a $0 balance, the account was not paid in full according to the original terms of the loan agreement. Credit scoring models consider "settlements' as severely negative indicators. The kicker is that both short sales and a deed in lieu of foreclosure are just as bad as a foreclosure when it comes to credit and credit scores.
If a short sale is going to hurt credit scores just as badly as a foreclosure, then what's the point?
Three reasons:
1) We all know that credit scores are very important and can make or break the ability to qualify for a loan. However, in the mortgage world there is still a bit of flexibility left when it comes to underwriting. The next time the borrower is in the market for a mortgage, the fact they made an effort to satisfy their previous mortgage obligation (instead of simply walking away from it) could work in their favor and be the difference between getting an approval or a denial. The money that homeowners borrow isn't play money. It's real money that came out of someone else's pocket, albeit probably an investor. Put yourself in the investor's shoes for just a moment. Wouldn't you rather have all of your money back? In the event you couldn't get all of your money back, wouldn't you much rather lend to someone in the future that at least tried to get you your money back rather than someone that did a deed in lieu or the most expensive of all to the lender; the foreclosure.
2) Fundamentally, the borrower is liable for the decisions they make and the loans they sign for. Whether they're in a bad mortgage loan because of market changes, or just because they made a bad choice, they have to bear some, if not all, of the responsibility. If making good on the loan in full is impossible, making good on as much of it as possible is the next best and ethical action they can take.
3) Lenders sometimes make mistakes when updating the credit report when they are updating a short sale and simply make the account a zero balance with no mention of settlement. This is unlikely but happens more often than most people think. If you are one of the lucky few that it does happen too, the credit score effect will be zero and may even increase the score since the loan was paid off.
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