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How does it impact credit?
I have a client wondering whether it makes more sense to just allow her house to foreclose or try to do a short sale.
Her financial advisor advised her she should let it go to foreclosure because if she opts for a short sale, she’ll get a 1099 for the difference between what she owes and what the bank ends up selling the property for. AND of course, she’ll have to pay taxes on that 1099 income.
I’m a Realtor and my thoughts are she should do a short pay because if she goes to foreclosure, she’ll be responsible for that difference PLUS costs which will amount to much more than paying taxes (Plus you can always strike a deal with the IRS for a payment plan without it affecting your credit). The bank that has the deed to her property isn’t going to let her get away free if she forecloses. They’ll come after her for that money with those fees for years, years.
And, with a short pay, the account comes up “settled” in her credit report.My question: How does one’s credit score differ between a short pay and a foreclosure? Is there a big difference?
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1 Reply
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When one looks at loss mitigation in the form of a short sale or a foreclosure for each of the clients, the client’s credit history raises several crucial points, which include the following:
Credit Score Effect:
Short Sale: According to Fannie Mae and Freddie Mac’s internal scoring models, foreclosures negatively impact the client’s credit history. That being said, short sales are looked upon more favorably. This effect, however, will still reduce the client’s credit. A short sale could reduce one’s credit between 150 and 50 points after a round-off, depending on the person’s credit perspective.
Foreclosure: It is reported in [various publications] that foreclosure is more catastrophic to loan performance as it is more easily measurable and results in greater losses. This leads to many clients not qualifying as it is estimated that they will lose between 300 and 100 points in the client’s rating and further avails of 7 years from thereon.
Credit Report Notation:
Short Sale: The account is resolved between the lender and the borrower, or rather the creditor and the debtor, resulting in them agreeing to do so via ‘settlement.’ Hence, these remarks state to any new lender that during purchasing transactions where money is disbursed to facilitate borrowing, the borrower attempted some form of settlement that might aid in future borrowing.
Foreclosure: The account goes to the creditor’s side, where it belongs, getting marked as foreclosed. This marks one’s account heavily and limits one’s chances of securing loans, credit, or even Rent Agreements shortly.
Long-Term Financial Impact: Although the borrower might owe taxes because a 1099 form is issued for the forgiven debt as a result of the short sale (meaning the borrower might owe taxes for that amount), the borrower is still able to avert the mortifying repercussions of foreclosure. The borrower will settle with the IRS on a payback plan if needed.
Otherwise, if foreclosure is filed, Borrowers will not only have a number of their credit files affected, but they might also face deficiency judgments after this period, which translates to paying the difference between the sale and the amount owed, consequently incurring additional debt.
Future Chances of Borrowing a Mortgage
After a short sale, a borrower can start obtaining mortgage loans again in two years or sometimes less, based on the lender’s criteria and the borrower’s credit score within these two years.
Furthermore, after a short sale, one must wait several years, or roughly seven after a foreclosure, to be granted a mortgage loan again.
All In all, it can be concluded by looking at the facts at hand that the impact of a short sale on one’s credit score jumping with time, the impact of a foreclosure on one score, and one’s overall financial conditions in the long run, make it better to carry out a short sale. Although in both of these instances, one’s credit score takes a massive hit, in the case of a short sale, it does have forgivable elements, and lenders are prone to say the recovery in credit score for a borrower will be quicker.
Urging your client to pursue a short sale may help them reduce their losses and prepare them for future lending prospects. If you have further inquiries or require support, do not hesitate to enquire!