The Complex and Seemingly Counter-intuitive Financial Situation
A short sale is a transaction in which the proceeds of a home sale fall short of what the owner still owes on the mortgage. The seller of property and their mortgage lender(s) must consent to the short sale process. Many lenders will agree to accept less than what is owed to them and release their lien interest. This agreement does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, known as the deficiency. Typically, on a purchase money mortgage (first lien interests); lenders will be willing to release the lien and release the borrower from deficiency liability. For second lien interests, such as home equity lines, the lender will release their lien interest, and may or may not pursue the borrower for a deficiency judgment.
Most second lien holders will accept a “pennies on the dollar” cash contribution or a promissory note at closing to extinguish the deficiency. For example, a lender may accept a $5,000 cash contribution or a promissory note for $12,000 at closing to release and extinguish a $100,000 second lien debt. By accepting a short sale, lenders can avoid a lengthy and costly foreclosure, and the owner is able to pay off the loan for less than what is owed.
In most circumstances, homeowners who experience foreclosure need to wait a minimum of five years to purchase another home, or three years with an FHA loan. The foreclosure is kept on a person’s credit report for seven years. Your FICO score will drop by over 100 points due to foreclosures, according to Barry Paperno, consumer operations manager at Fair Isaac (it will also drop after a short sell, probably, due to you being in default on mortgage payments). This may seem like a relatively small amount for a default on a major asset, but it’s enough to cause credit card companies to consider rate hikes and credit limit decreases, and for insurance companies to raise premiums.
The Benefits of a Short Sale
- Damage To Your Credit Is Reduced: A short sale has a reduced impact on your immediate score and a reduced impact over time to your credit score. Although your credit “score” is important your “creditworthiness” and ability to obtain credit is more than just your credit score. For instance, you will be eligible for Fannie Mae & Freddie Mac home financing after 2 years if you short sale your home. You will not be eligible for Fannie Mae & Freddie Mac financing for a minimum of 5 years if your home is foreclosed on. This has nothing to do with your credit score and everything to do with the way the financial crisis has altered mortgage underwriting guidelines.
- No Out Of Pocket Expenses & Cash Back: Virtually all short sales are sold “as-is”. You won’t have to bother spending time and money on home repairs. Your lender pays all fees, services, and commissions on both sides of the transaction. Lenders are also offering homeowner relocation assistance from $3,000-$15,000 to motivate and cushion the seller’s transition out of their home.
- Get A Fresh Start: A short sale provides a clean break from your mortgage hardship. More than half of homeowners that have obtained a successful loan modification wind up in default again. The scope of loan modifications at present time is such that the relief provided isn’t providing a long-term solution for homeowners. The interest rate may be lowered and/or the debt can be amortized over a longer period of time, but the negative equity says. For homeowners who are upside down $100,000+, this means the break even sale point is years down the road.
- Maintain Your Dignity: A short sale allows you to stay in your home during the negotiation process and leave at the close of escrow just like a traditional sale. The foreclosure process involves bank representatives making periodic property inspections and the formal posting of a sale notice right on your home itself. The last stage even brings the local Sheriff to your property to have you forcibly evicted.
- Reduce Your Exposure to Loss: The recent enactment of the Making Homes Affordable guidelines in April 2010 (and extended thru 2013) encourages lenders to accept short sale and deed-in-lieu transactions with no deficiency against the borrower. Read up on the HAFA Program eligibility requirements to see if you quality. HAFA short sale guidelines also call for a maximum of $8,500 to be paid toward second liens on the property with deficiency waiver.
- You Will Have An Easier Time Renting. A foreclosure and/or eviction are red flags to potential landlords who may decide not to accept you as a renter or increase the security deposit required. While a short sale is being negotiated you can take your time to select a new place to live and landlords generally apply more lenient requirements on short sellers vs. those who have been foreclosed upon. Landlords are creditors too. It’s common sense… they can see that you made every effort to do the right thing with your previous obligation rather than tuck your tail and run leaving the creditor (your mortgage lender) high and dry.