Thursday, September 18, 2008


Foreclosures and short sales are forms of “settled debt” as opposed to “paid debt.” Both are are highly damaging to your credit profile.

From Vitek, one of the country’s biggest lenders:

A foreclosure will result in a credit report deduction of 200 to 300 points.
A short sale will result in a credit report deduction of 200 to 300 points.

Fair Isaac's proprietary formulae (some would prefer the term "inscrutable" formulae) also indicate roughly equal credit damage.

What’s the difference?

The difference is like being hit by a car going 100 mph or being hit by a truck going 100 mph. Not much. You are hurt either way.

My realtor promises that a short sale will result in less credit damage than a foreclosure.

I have read numerous, and differing, opinions on this debate, and the best that I can say is that there may be a slight advantage to the borrower who stays "at the table" and works with the lender toward a short sale. It depends on several variables, among them are:

  • The Borrower--how many late payments on the mortgage before the settled debt, the nature of other elements in the owner's credit profile, the credit score before the settlement, and the credit history after the settlement may all affect the credit score.
  • The Lender--there are great differences between lenders and how they handle bad loans.
  • The Loss--how big a hit is the lender taking on the loss?
  • The Agreement--sometimes a short sale agreement between Owner and Lender may provide a measure of protection for the Borrower in exchange for cooperation in the short sale.
  • The State in which the property is located. California, for example, provides for "non-judicial" foreclosures in most cases. This has significant ramifications for deficiency "judgements." You can't have a deficiency judgement in a non judicial procedure.

Be wary of any realtor who promises to reduce your credit damage by listing your property as a short sale. In a short sale the realtor will still get a commission. You, however, will get nothing (nada, zilch, zero) except credit damage.

How long after a short sale or foreclosure can I obtain another mortgage?

Not as long as you probably think. Some sources state 3 years, some sources state 4 years, some sources state 18 months! Fannie Mae (remember her?) stated 2 years for a hardship based short sale and 5 or more years for foreclosures. You will not, however, get very good interest rates for a long time.

If I sell "short" can I get the lender to desist from sending a damaging credit report to the credit bureaus?

Highly unlikely. I have heard it through the "Blogvine" of instances where damaging credit reports have been avoided through some "agreement" with certain lenders, but I have never personally seen it happen. The best answer to this question is . . . don't count on it.

When will the credit damage begin?

It will begin as soon as you stop making your mortgage payments on time ("lates") or start missing mortgage payments altogether. This damage could begin months before the lender actually files a Notice of Default (NOD), months before a short sale, months before your home is auctioned off and foreclosed.

Besides getting slammed by a low credit scores, are there other credit consequences resulting from a "settled" mortgage debt?

Yes, unfortunately. You can expect the interest rates and penalties on all of your credit cards to absolutely skyrocket, then skyrocket again. This is utter disaster if you have large balances on your cards. And, by the way, where are you going to live?

What should I do if there is no way to avoid short sale or foreclosure?

If you have exhausted the possibilities of working out a deal with the lender that lets you stay in your home (this is another topic all by itself), then I offer this advice:

  • Pay off your credit card balances as soon as possible and get credit counseling. If you have trouble paying off your credit card bills every month, that in itself may be a major contributor to your financial problems. Consider destroying all or most of your cards. At least try to use them sparingly--and pay them completely off every month!
  • Find a new place to live before your credit scores go into all the way into the toilet.
  • Stop beating yourself up. You are in good company. Whose homes have been foreclosed lately? Doctors, bankers, lawyers, professors, business executives, real estate brokers, M.C. Hammer,Ed McMahon, and the family that lives right down your street.

What are the tax implications of a short sale or foreclosure?

This question is another topic unto itself. I cannot stress strongly enough that your personal situation must be scrutinized by a competent tax CPA, attorney, or other tax expert in regards to your specific situation. Real estate agents are not qualified to give tax advice.

Should I declare bankruptcy?

There is more than one kind of bankruptcy. It is a procedure with numerous complications and profound consequences, and, by the way, bankrupcies are not cheap! The decision to file for bankruptcy must be discussed with an attorney with expertise in this area before you make any moves. It is my understanding that filing for bankruptcy freezes or stalls foreclosure proceedings, but you may be trading that 100 mph collision with a truck for getting struck by lightning.

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