With the ever changing credit and lending market, this information could change tomorrow. We as investor’s get asked which is better a foreclosure or a short sale, and while neither are desirable there are pros and cons to each.
If a borrower let’s their home go into foreclosure, they could essentially live in the property for several months after the foreclosure auction until the lender or the buyer at sale pays them to move out or evicts them. So in essence they could profit by 3 or 4 months worth of rent, and if they get paid to move , could net another $500 to $1000.
If the borrower decides to try to sell with a short sale, they need to list with a realtor to find a buyer or an investor buyer, the property will need to be viewed. Because realtors need to disclose the property is a short sale, the seller can expect to receive low ball offers and if they work with an investor to speed up the property, they will also be receiving low offers. The lender will not tell the borrower what kind of price they might take until they get an offer, so it could take a few months to get an offer to work with and then another month or so to get the offer negotiated to approval or rejected to find another buyer.
Once the seller gets an offer, then the negotiation with the lender starts. In the past the seller needed to be behind on payments to be able to negotiate a short sale, but now most lenders will consider a short sale on most loans. But if the home is in good condition, the lender is not going to short too much and if the borrower has a lot of cash assets, a higher income, or is an investor, the bank may be less inclined to negotiate.
The borrower’s also the differences of foreclosure vs short sale on their credit. From an article on About.com by Elizabeth Weintraub and her source David Steep a division manager at Vitek Mortgage.: foreclosure, deed-in-lieu of foreclosure and short sales all have a huge affect on credit.
When looking at foreclosure vs deed-in-lieu, both have about the same affect on the borrowers credit. The article notes that it could drop credit by 200 to 300 points depending on the original credit score. And it notes that a short sale can do about the same thing.
Then the next question is how long will this affect the borrowers credit. And it will be on the credit report for quite a while, but the borrower should see lenders willing to work with them in about 2 –5 years. And if you sell through a short sale, Fannie Mae Guidelines are creating programs that will help in 2 years.
After the short sale or foreclosure or deed-in-lieu the lender could file a deficiency judgment against the borrower for the difference between the amount the home sells for at auction or short sale and what is owed plus attorney and court fees. Usually always if the property is sold at auction a deficiency is filed while if a short sale or deed-in-lieu is negotiated, the deficiency judgment is a negotiating point. Deficiency judgments will be affected by the type of loan purchase money, hard money, equity loans, and refinances . The first may not be subject to judgment while the latter 3 are more likely to have one. This is a subject to talk to your tax advisor, and attorney.
If the lender agrees to forgive the debt and not issue a deficiency judgment, the IRS wants their cut. So the lender will issue a 1099 to show the borrowers income as forgiven debt is income in the eyes of the IRS.
So which is better, the foreclosure or the short sale? Well the process of selling and the time in the property is one factor, the deficiency judgment is another factor, and time to get a new home loan is also a factor. But the affects to the current credit score is about the same for both. But again because the rules and regulations are changing daily, please look to an attorney and a competent lender for advice.
If you factor in the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than 2 million. So virtually every homeowner out there who decided to sell their primary residence through a short sale, can negotiate with the lender to not receive a deficiency judgment and the IRS will not require a 1099. For debt forgiven in 2007, 2008, or 2009.
Debt forgiven on second homes, rental property, business property, credit cards, or car loans does not qualify.
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