Should You Choose a Short Sale Over a Foreclosure?
The Pros and Cons of Allowing Your Lender to Lose Money on Your Home
Whether you should make a short sale or let a home go to foreclosure depends on several factors. While for some homeowners, it is easier to throw up their hands and let the bank take the home, that might not be the wisest thing to do. Regardless of which approach you choose, always obtain legal and tax advice before deciding.
Benefits of Both
The main advantage of a short sale is that you're in control of the sale, not the bank. Your home sale will be handled like any other home sale, and you may prefer being involved in the selling process and knowing who is buying your home. There is also a negative social stigma that comes along with a foreclosure. Many people find it embarrassing and want to avoid the process by any means. You can also be current on your payments and still apply for a short sale.
The main advantage of foreclosure is it's an immediate solution and saves you money. If foreclosure is seemingly inevitable, you can just stop making payments and live in the home until you get kicked out. Once that happens, you can leave the home behind and simply walk away. If something happens to break or malfunction during that time, you don't have to fix it.
Fannie Mae's guidelines allow you to reapply for a mortgage four years after a short sale with a 10% downpayment. If you sold your home as a short sale due to extenuating circumstances, you can reapply for a Fannie Mae-backed mortgage after two years with appropriate documentation of the circumstances. You may also qualify for an FHA loan one year after a short sale.
Bear in mind that Fannie Mae and FHA guidelines are not a guarantee you will be able to buy a home after suggested timeframes. Banks have the final say and often include overlays that can change the guidelines set forth by the government. Ask your loan officer to clarify before relying on federal guidelines.
If your foreclosure was due to extenuating circumstances, you may be eligible to buy another home in three years. Otherwise, the standard waiting period remains seven years. Similar to its short sale guidelines, FHA allows those who foreclosed on their homes to reapply for mortgages after 12 months.
Effect on Credit
A short sale may be considered to be a derogatory mark on your credit even though credit bureaus do not call them that on your credit report. Your credit report may read "settled for less than full balance," among other categories. Certain HAFA guidelines allow for "no hit to credit" and can show up as paid in full. Depending on your credit history, FICO offers two examples in which a credit score could fall significantly after a foreclosure. Generally, a foreclosure remains on your credit report for seven years.
Judgments are often negotiated between the seller and the short sale lender. In some states, such as California, if the home is your personal residence and was financed through purchase money, there is no deficiency judgment. Banks are generally unwilling to negotiate deficiency judgments with the homeowner after a foreclosure.
Loan Application Questions
Loan applications typically do not require you to include information about short sales. You are, however, required to note if you've ever had a property foreclosed or given a deed-in-lieu thereof in the past seven years. If the lender sees you have had a foreclosure, your loan may be denied.
Length of Time to Relocate
If you've had a foreclosure notice filed, you may be able to postpone that action while the bank considers a short sale. The wait for short sale approval can take a few months. In a foreclosure, unless prior arrangements have been made, the lender may want you to vacate the property immediately and may commence eviction proceedings if you delay.
A personal residence is exempt from mortgage debt relief on a federal level as long as the government continues to extend this exemption, but some states still tax you. An investor is also not exempt from mortgage debt relief, subject to certain conditions. For owners who foreclose on their homes, some lenders immediately send out 1099s, which reports the amount of relief as compensation to the owner, even if the owner is exempt.
Federal Housing Finance Agency. "FHFA Announces New Standard Short Sale Guidelines for Fannie Mae and Freddie Mac." Accessed March 29, 2020.
Fannie Mae. "B3-5.3-07, Significant Derogatory Credit Events — Waiting Periods and Re-establishing Credit (08/07/2019)." Accessed March 29, 2020.
California Association of Realtor. "2013 Q&A Revisions." Accessed March 29, 2020.
Freddie Mac. "Uniform Residential Loan Application," Page 5. Accessed March 29, 2020.
IRS. "Home Foreclosure and Debt Cancellation." Accessed March 29, 2020.