Short Sale vs. Foreclosure: What’s the Difference between Them and Which One Hurts My Credit (FICO) Score More?


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As the home foreclosure crisis rages on, more and more homeowners are considering options that they never thought they’d have to consider. And, with deadlines pending that can greatly impact future finanical decisions, it’s imperative that the right decisions are made at this critical time.

Here, we’re going to discuss the differences between a foreclosure and a short sale, and the credit impact of each. But first, let’s clearly define what they are.

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What Is a Foreclosure?

A foreclosure occurs when the lender takes ownership of a property away from the owner. In legalese, it is “the termination of all of the rights that a mortgagee (the homeowner) has in a property.”

This usually occurs because the owner has defaulted on mortgage payments. But, it can also be due to property taxes being owned, HOA fees not being paid, a contractor’s lien, etc.

What are the Stages of the Home Foreclosure Process?

The foreclosure process is usually initiated when a lender notifies the mortgagee that payment is delinquent. This is done via a Notice of Default (NOD). Learn more about all of the stages of the home foreclosure process.

What is a Short Sale?

A short sale is when a lender agrees to accept less for the property than what is owed on it. In essence, a buyer purchases the property directly from the lender at a discount.

For example, let’s say you’re facing foreclosure and you owe $100,000 on your home. But, because the foreclosure crisis has hurt property values, your home is only appraised at $73,000 and you have a buyer who is willing to pay that.

If the bank (lender) agrees to accept this as “full” payment, then you sell the home for $73,000; $27,000 “short” of what is actually owed on the mortgage.

Tax Implications of a Short Sale: You Could Wind Up Owing a Lot of Money in Taxes If You Short Sale Your Home after December 2012

Most times, you as the owner would be responsible for the “short” fall – as in, the government looks at it as “income” and you have to pay taxes on that. Yep, that’s right, you could wind up owing taxes when you do a short sale.

But, current legislation in place protects you from this penalty – if you act by a certain date. Following is more on this.

Why is this? We explained it in post we did earlier this spring about options for homeowners who are facing foreclosure, writing:

Home Foreclosure and Taxes: Important Tax Consequences of a Short Sale after December 31, 2012

For example, if you owe $200,000 on your home and you sell it for $100,000, the government will tax you on the $100,000 difference because it’s seen as a financial “windfall.” So if you’re going to do a short sale, be sure to do it BEFORE December 31, 2012.

Remember, in this market, it’s taking homes months and months — some more than a year — to sell. So if this is an option you’re considering, don’t delay too long. FYI, the tax break applies only to primary residences.

Learn more about The Mortgage Forgiveness Relief Debt Act and Debt Cancellation law — and the tax implications of a short sale.

Why Lenders Accept Short Sales

There are several reasons, ie:

Banks Are Not in the Real Estate Business: Banks are not realtors – and they don’t want to be. They want to make money from lending money – not buying and selling property. Hence, they don’t like to hold on to “housing inventory.”

So, they tend to sell it as quickly and expeditiously as possible. FYI, this is also why banks are willing to work with homeowners to stop foreclosure where possible.

Foreclosing Is Expensive: In many cases, it costs lenders more to foreclosure on a home than to work with a homeowner to prevent foreclosure. How much more? Consider this (from the linked-to post just above):

A report by the Joint Economic Committee of Congress estimates that the average cost of a foreclosure, to the homeowner, lender, local government, and neighbors (whose homes decline in value), is $78,000. By contrast, preventing the foreclosure would cost $3,300 per home on average.

So even though a short sale may bring in less, lenders are willing to accept it because the sooner they can get rid of the “toxic asset,” the sooner they can move on.

Maintaining Foreclosed Property Is Expensive: When a home sits empty, the owner (in this case, the foreclosing lender) risks vandalism and squatting, not to mention the maintenance and upkeep that’s required (eg, cutting the grass, securing the locks, winterizing, etc.).

Incidentally, this is why many lenders pay homeowners to leave (ie, offer cash for keys), so they can do a short sale to get rid of the property.

Now that you know what a foreclosure and a short sale are, let’s look at the differences between them.

Differences between a Short Sale and a Foreclosure

Possession: A short sale happens while the homeowners still has possession. In a foreclosure, the lender takes possession.

Selling Agent/Selling Process: Foreclosures are not sold by realtors; they’re sold by the lenders (usually at auction the courthouse steps of the county in which the property is located. The property owner doesn’t participate in the process. During a short sale, the homeowner is still part of the selling process.

Tax Consequences: A lender can sue you for the difference owed if the foreclose and they don’t sell the property for what’s owed on it.

While this can happen when you short sale your home too, it’s less likely to happen because you can do a short sale with “no recourse.” This means you ask the lender not to come after you for the difference (ie, take no legal recourse against you for the balance owed). Of course, they’d have to agree to it and you (and they) would sign papers to that affect.

For the reasons stated above, many lenders will gladly agree to a short sale with no recourse.

Which Hurts My Credit More – A Short Sale or a Foreclosure?

Contrary to conventional wisdom, the impact of a foreclosure and a short sale on your credit score is basically the same. Proof?

A few years ago, Fair Isaac, the people who invented the current credit scoring system (the FICO score), published a table showing exactly what happens to your credit score when you do a short sale, have a foreclosure, and/or go through bankruptcy.

Following is the data.

How Much Your Credit Score Is Lowered When You Do a Short Sale or Go Through Foreclosure

Consumer A

Consumer B

Consumer C

Starting FICO score

~680

~720

~780

FICO score after these events:

30 days late on mortgage

600-620

630-650

670-690

90 days late on mortgage

600-620

610-630

650-670

Short sale / deed-in-lieu / settlement (no deficiency balance)

610-630

605-625

655-675

Short sale (with deficiency balance)

575-595

570-590

620-640

Foreclosure

575-595

570-590

620-640

Bankruptcy

530-550

525-545

540-560

The real difference between the two when it comes to credit is how quickly you can recover. Time It Takes Your Credit Score to Recover from a Short Sale and a Foreclosure (and Bankruptcy)

Consumer A

Consumer B

Consumer C

Starting FICO score

~680

~720

~780

FICO score after these events:

30 days late on mortgage

~9 months

~2.5 years

~3 years

90 days late on mortgage

~9 months

~3 years

~7 years

Short sale / deed-in-lieu / settlement (no deficiency balance)

~3 years

~7 years

~7 years

Short sale (with deficiency balance)

~3 years

~7 years

~7 years

Foreclosure

~3 years

~7 years

~7 years

Bankruptcy

~5 years

~7-10 years

~7-10 years

How Long Does It Take to Qualify for a Home Loan After a Short Sale?

According to 2008 Fannie Mae guidelines, you can qualify for an FHA home loan after a short sale anywhere from right away (ie, immediately), on up to 24 months.

Note: In order to qualify immediately for an FHA loan after doing a short sale, you must never have been late on your mortgage.

Learn more about how to qualify for a Fannie Mae home loan after a short sale, foreclosure, deed in lieu of foreclosure, etc. [link is to a pdf file]

How Long Does It Take to Qualify for a Home Loan After a Foreclosure?

You may have to wait anywhere from three to six years after a foreclosure to get a home loan. This is the main reason short sales are often preferred over having a foreclosure on your record.

Which One Is Better for My Credit Score: A Short Sale or a Foreclosure

This is a personal decision because it depends on what your long-range goals are. However, in most cases, if you have a choice, go with the short sale over the foreclosure. It’s the wiser decision — especially if you want to qualify for a home loan again in the next few years — in the long run.

Related Posts

Bank Foreclosure: Banks Walking Away from Foreclosed Homes

Home Foreclosure News: 9 Million Homeowners Could Go Into Foreclosure Between 2009 & 2012

Stop Foreclosure: How to Ready Your Home for a Fast (Short) Sale

P.S.: Bank Failures Can Mean Big Business for Foreclosure Cleaning Businesses! Visit this link to see which banks closed have closed recently. Then, learn how to use bank failures to grow your foreclosure cleaning business.

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Copyright © 2011 Yuwanda Black for Foreclosure Business News. Article may not be reprinted or reproduced in any manner without the express, written consent of the author.

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