Short Sales vs. Foreclosures

As the foreclosure crisis continues largely unabated by the Making Home Affordable program, we are now seeing a push from the government for servicers and lenders to consider short sales. A short sale is where the property is sold for less than the balance of the mortgage note.

Pushing short sales is not an acceptable answer to the foreclosure crisis. No amount of coercing from the government, absent the force of law,  will get mortgage servicers to accept the kind of offers  a homeowner is likely to receive, especially in areas where home values have plummeted over 20%. 

 

A short sale, especially in areas where housing values have declined sharply, such as in California, would require that lender accept losses of upwards of $100,000 per home. If they’re unwilling to accept the modest losses necessary to make truly affordable and decent loan modifications, why on earth would they accept the larger loss necessary to complete a sale at today’s values?

This post on Blown Mortgage highlights the supposed benefits to a short sale over a foreclosure.

Benefit 1. Buying a Home. It is much easier, and faster, to buy a home after a short sale than after a foreclosure. If you foreclose on your current mortgage you might be eligible for a loan after five years if your current mortgage is your primary home. If the home you foreclose on is your secondary home you will have to wait seven years. However if you short sale you could apply for a Fanny Mae mortgage immediately if you were not behind on your payments. If you were behind in your payments you will have to wait 2 years.

The last bit of this makes me laugh. If you weren’t behind on your payments, you can qualify for a Fannie Mae mortgage right away after a short sale.  I’m going to ask a foolish question here, but why on earth would you ever want to consider a short sale, a process that is neither quick nor pleasant, if you are current on your mortgage?  The only reason I can see to even consider this is where you need to relocate due to your employment and you need to sell your home. Even then, renting out your home would be a better option than jumping through the hoops to get a short sale approved.

Benefit 2. Getting a Loan. Even if you are not planning to buy a home any time soon you will probably want to get a loan. A foreclosure will destroy your chances of getting a reasonable loan for up to 7 years. There is a question in every loan application that asks if you have foreclosed on a mortgage. If you lie you can be investigated for fraud, if you tell the truth you can kiss goodbye your loan

This statement completely ignores the reasons why so many people are facing foreclosure: a decline in income or a bad loan.  Very few people who are currently facing foreclosure will be able to obtain any sort of credit any time soon. Why? Credit markets continue to remain tight and lending standards have tightened across the board.  Going through the hassles of a short sale on the mere notion that perhaps you’ll be able to obtain financing sooner is ludicrous given the current economic situation.

Benefit 3. Your credit rating. Credit rating is not only important to get a mortgage or a general loan. It is also used by employers when selecting potential employees, and landlords when screening tenants. The bad news is that foreclosures destroy your credit rating. Credit rating ranges from 300 (dismal) to 850 (excellent). A foreclosure will drop your rating by anything from 200 to 400.

However, a short sale will either nudge your rating down by a 100, or not affect it at all, because many lenders do not even report short sales to credit bureaus. Add to these benefits the fact you could get a $3,000 incentive and you should be able to answer why it is better to apply for a short sale from your lender than simply sending him some jingle mail.

Ok, major reality check here: if you’re facing foreclosure, your credit is already in the toilet. Being behind on your mortgage payments has already wrecked your credit rating. A short sale won’t save it enough for it to be worth the trouble for most people.

Another aspect of this that I want to point out is that in many cases, a short sale could leave you still owing the difference between the amount for which you were able to sell your home and the amount of your mortgage note. So, you would still owe the bank money for a house you no longer own and no longer live in. With foreclosure, most states prohibit the bank from entering a deficiency judgment against you for the difference between the proceeds of the foreclosure sale and the amount of the note.

The government should be focusing on strengthening the HAMP program instead of dabbling with the idea of short sales. There is actually only one thing that needs to be done that would give HAMP some teeth: allow bankruptcy judges to write down the principle balances on mortgage notes for primary residences. In fact, this one simple thing would make both loan modifications and short sales easier to accomplish.

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5 Responses to “Short Sales vs. Foreclosures”

  1. Emily says:

    I read this and just about choked. How very like our government to talk out their behinds.

    One thing you didn’t mention, but you’re also required to pay taxes on the forgiven debt! Say you short-sell your $180,000 home for $150,000, the IRS considers the $30,000 income and you’ll be hit with paying the 25ish % income tax on it. And that’s nothing to say about state and/or local fees. This was one of the biggest reasons we let the house go into foreclosure. Maybe if the government fixed that stupid rule, taxing people on “income” that never came in…nah. Without stupid rules, our government would be nonfunctional.

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  3. Kathy McGraw says:

    Emily:

    Good catch. There are definitely task consequences to short sales that no one is really taking about.

    Some states are attempting to pass legislation that would exempt at least short sales from being taxable, but as of now, in most states, the difference between the sales price and the amount owned is most definitely taxable.

  4. Tawana Marusarz says:

    Thanks so much for the article.Really looking forward to read more.

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