Going through a short sale vs foreclosure is difficult. What you need to know about each and how you can get out of them is important if you want to save your house and credit.
I personally went through a short sale in 2010 and it was not easy. There were many things you had to do to be in compliance with the bank. Ultimately, after 4 months, we finally sold our house in a short sale vs foreclosure.
A short sale comes before the foreclosure and there is much more to learn about short sale vs foreclosure.
In this article, we are going to learn everything we need to know about the short sale vs foreclosure and how you can get out of them.
First, What is a Short Sale?
Before the start of the process, the lender who holds the mortgage, usually a bank, should give approval for the execution of the short sale. The bank also requires documentation explaining why the short sale is necessary as there is the possibility that lots of money will be lost along the process.
Once the short sale is approved, the buyer will first negotiate with the seller and seek approval from the bank for the purchase. Short sale cannot be executed without the approval of the lender since the lender is the one who will incur an investment loss instead of the seller.
A short sale tends to be a paperwork-intensive and lengthy transaction. There are times when the process can take up to one year. But, this process doesn’t cause as much damage to the credit rating of the real estate investor, unlike foreclosure.
To future creditors and lenders, a short sale looks better since it shows that the investor took action way before the bank repossesses the investment property.
Borrowers who have undergone a short sale can be qualified to buy another property right away in such situations.
Second, What is a Foreclosure?
A foreclosure occurs when a borrower stops paying the debt owed to the bank and the bank will remove the rights of a person to own and possess the real estate property.
The person will no longer be the owner of the property after the foreclosure and he or she will have to remove their belongings and leave the property.
The company or person who holds a lien on the property is the one who starts a foreclosure.
Third, Advantages of Short Sale vs. Foreclosure
Short sale has a few advantages compared to losing your property to foreclosure:
Shorter wait time
Short sales go on credit reports as discharged debts that are not fully paid. Potential creditors will see this information for a maximum of 7 years. However, with a short sale, you can be qualified to purchase another property sooner compared to foreclosure. The Fannie Mae regulation state that borrowers are eligible to purchase loan two years after the short sale process, a shorter time compared to 5 years after foreclosure.
Psychological comfort
Some people experience the moral and social stigma of losing their property to foreclosure. With a short sale, you will more satisfied when you know that you will be discharged as much of your financial obligation as possible instead of simply walking away from your mortgage.
Short Sale vs. Foreclosure Credit Impact
A short sale can cause the credit score can drop to 50 points if no late mortgage payments are incurred during the process. However, this drop can go up to 200 points if late payments are incurred during the process.
Borrowers with the top-tier 760 credit scores or higher enjoy the lowest rates but these can rise if there is a drop in the credit scores. Applying for a new loan after short sale may only take 2 years if you give a down payment of 20% or more. If you are putting 10% down, you will have to wait for up to 4 years.
But, with the improvement of the credit markets years after the financial crisis in 2008, there are lenders who are willing to lend sooner. You have to talk to your tax preparer about tax consequences you will face regarding the part of your loan that your lender has forgiven.
In a foreclosure, credit scores could drop 200 up to 400 points. A foreclosure can hit your credit harder compared to a short sale. This is because you will be accruing late payments for your mortgage on the way to foreclosure.
You might have to wait up to 7 years before you can apply for a new loan after foreclosure. However, this can be made shorter if your difficult situation was out of your control, like a job loss. All you need to do is connect with the lenders to find one willing to lend sooner. Don’t forget to specify that you recently went through a foreclosure.
Can You Do a Short Sale While in Foreclosure?
Maybe or maybe not. Starting a short sale wouldn’t stop the foreclosure automatically.
But, most of the time, lenders could be convinced to delay the foreclosure to allow the negotiation for short sale to take place.
Although there are really no guarantees, it wouldn’t hurt to give it a try.
Pros and Cons of Short Sale vs. Foreclosure
Short sale offers several benefits including the following:
- The sales process is under your control instead of the bank.
- You can save yourself from the social stigma associated with foreclosure.
- You can sleep better because you know who will buy your home.
- The sale of your home will be handled just like other sales with the utmost dignity and respect.
- You could stay current on payments and apply for a short sale.
On the other hand, the cons of a short sale include the following:
- A short sale can still harm your credit because whether you like it or not, it is still a type of debt that fully paid.
- Although the sales process is under your control, the lender is the one who decides if the process can proceed or not. The lender is also the one that will set the time frame and negotiate the price.
- You are not yet off the hook for your loan’s balance after the lender agreed to the process. Unless there is a clause included in the sales contract that explicitly frees you from further indebtedness, your lender can approve the process, take all proceeds, and file a deficiency judgment against you.
Choosing to undergo foreclosure also has its benefits:
- This is an immediate solution.
- You don’t need to fix things if they malfunction or break down.
- You could stop making your payments and still live in the property until you are evicted.
- You can leave the property behind and walk away.
The cons of foreclosure are the following:
- The primary downside of foreclosure is none other than losing your home.
- Borrowers who underwent foreclosure usually lack the money to pay a rental deposit. Their credit rating might also hinder them from applying for a new mortgage.
- A foreclosure creates a negative impact on how other lenders think of you.
- You might find it harder to search for a job.
Short Sale vs. Foreclosure Tax Consequences
You might owe taxes because of the short sale or foreclosure of your property that depends on the specific circumstances. The IRS states that short sales and foreclosures are both considered as taxable transactions in real estate.
If your lender forgives part or all of your mortgage debt, cancellation of this excess debt can be considered as taxable income and your lender will send you a Form 1099-C.
The difference between the property’s fair market value and the amount of canceled debt should be included in gross income indicated on the tax return unless there is an applicable exclusion or exception. In some cases, like foreclosure of the primary residence once specific conditions have been met, all or some of the debt cancellation might not be taxable.
If the foreclosure includes debt cancellation, you will be obliged to report this as ordinary income if the entire mortgage is your personal liability in spite of the security interest the lender takes in the property.
This amount is going to be indicated in Box 2 of 1099-C that your lender is going to send you.
Just like foreclosure, debts canceled by your mortgage lender because of a short sale will be taxable only when your mortgage’s terms hold you personally liable for the full loan amount. Regardless of tax consequences, the lender is going to report this debt cancellation on the 1099-C form.
How to Get Out of a Short Sale or Foreclosure
There are several things you can do to get yourself out of short sale:
- Start with a loan modification. Under HAMP or Home Affordable Modification Program, most homeowners can be qualified for lower payments to allow them to stay in their property. But, you cannot apply for loan modification and a short sale simultaneously. More often, you should start first with the process of loan modification then proceed to the short sale. If you will move directly to short sale mode, your short sale will be immediately stopped if you apply for a loan modification.
- Make sure you catch up on payments. Banks are after the cash that you owe them and not selling the property at a loss.
- Choose to rent out your property. Instead of proceeding with the process of the short sale, you can rent out your property for a higher price than your usual monthly payment to let you catch up on your overdue balance so you can stay current on your mortgage.
- Don’t send in the paperwork yet. A short sale typically comes with strict guidelines from mortgage companies and you have to do everything within the right time frame or else, the short sale is going to end.If the signed agreement for short sale gets lost along the way or you forgot about it, your mortgage company is going to stop the process of short sale.
Steps to Get Out Of A Foreclosure
- You can get out of foreclosure by filing for bankruptcy. If the schedule for the foreclosure is set in just a matter of days, you can stop the sale right away if you file for bankruptcy.
- If you don’t like to wait until the last minute, you can delay the foreclosure if you apply for a loan modification or any other option for foreclosure avoidance since the bank will be restricted from dual tracking.A dual-tracking happens if the bank continues with the foreclosure even if there is a pending application for loss mitigation.Upon the approval of the modification application, it will put a permanent stop on the foreclosure provided that you continue with modified payments.
- If the bank uses a nonjudicial process to proceed with the foreclosure wherein the completion of the foreclosure is made outside the court system, you can stop or delay the foreclosure if you file a lawsuit against your bank as a way of challenging the foreclosure.