Homeowners who are struggling with their mortgage payments have several options. Two of those options are a short sale and foreclosure. With a short sale, you get permission from your lender to sell your home for less than you owe on the mortgage. With a foreclosure, the lender seizes the home and sells it at auction.
Whether you should make a short sale or let a home go to foreclosure depends on several factors. For example, you may be able to buy your next home sooner with a short sale than a foreclosure. 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.
What's the Difference Between a Short Sale and a Foreclosure?
|Can qualify to buy again with a conventional mortgage in four years||Can qualify to buy again with a conventional mortgage in seven years|
|Deficiency judgments can be negotiated||Deficiency judgments can't be negotiated|
|Not required to mention on future home loan applications||Required to mention on future home loan applications|
|May take a few months||May be immediate|
Fannie Mae's guidelines allow you to reapply for a mortgage four years after a short sale with a 10% down payment. 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. Freddie Mac has similar requirements. 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.
If your foreclosure was due to extenuating circumstances, you may be eligible to buy another home backed by Fannie Mae or Freddie Mac 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 apply for a new mortgage after 12 months.
A deficiency judgment is when you're required to pay the difference between what the home is sold for and your mortgage balance. 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.
Home 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.
Taxes are another factor to consider. 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.
It's also worth considering the impact on your 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. Foreclosures have a similar effect on your credit.
Generally, both a foreclosure and a short sale remain on your credit report for seven years.
The Bottom Line
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 spend the money to fix it, which can also save you money.
Freddie Mac. "Adverse or Derogatory Credit Information."
HUD. "HUD 4155.1, Mortgage Credit Analysis for Mortgage Insurance," Page 175.
Fannie Mae. "Selling Guide."
California Association of Realtor. "2013 Q&A Revisions."
Freddie Mac. "Uniform Residential Loan Application," Page 5.
Federal Housing Finance Agency. "FHFA Announces New Standard Short Sale Guidelines for Fannie Mae and Freddie Mac."