Short Sales and the FICO Score
Monday, July 7th, 2008 | Real Estate Investing, Short Sales
By Josh Cantwell:
It’s not hard to find chatter on the blogs concerning how a short sale or a foreclosure affects a FICO score. Frankly, even if it were the same, the differences between a deficiency judgment and a negotiated note are considerable: There’s no gray area here.
As a homebuyer you need to be sure to explain the benefits to the homeowner if you are able to buy their house, as well as the negatives if the house should be sold at auction.
In the past, investors have claimed that a foreclosure would greatly harm one’s credit while a short sale would allow the homeowner to move forward to enjoy a faster recovery. What has been implied in this statement is that the overall damage to one’s credit in terms of points would be greater in a foreclosure than a short sale, when in fact there may be little credit preservation advantage of a short sale over a foreclosure.
As a result, many homeowners have been advised by real estate professionals who saw little benefit in a short sale to allow the house to go into foreclosure.
This was wrong.
Make no mistake, there are definite advantages to a short sale beyond allowing the homeowner to move on emotionally from the foreclosure, but it has little to do with how many points a short sale will drop a FICO versus a foreclosure.
Naturally, the best outcome for the homeowner is to sell the house for what they owe on the balance of their mortgage, if not more. For real estate agents, this is what they hope to do for each of their clients. Unfortunately, in most communities, houses are over valued and markets will no longer support asking prices. Likewise, as of this writing, only three communities in the US currently having rising appreciation, strong sales and few if any foreclosures. Only three! If the homeowner is unable to structure a workout or a forbearance agreement with the foreclosing lender, then a short sale is the next best option.
The benefits are twofold.
First, be aware that Fannie Mae recently established a 2-year elapsed time period for reestablishing credit for homeowners who sell their homes through a short sale. Two years may seem like a long time to wait before being able to get a new loan, but compare this to what happens if the homeowner goes through the foreclosure process. According to the Fannie Mae guidelines, effective May 31, 2008, a homeowner who has filed a foreclosure will be “ineligible” for a loan for five years.
Did you see that? FIVE YEARS!
Two years or five years…? That’s something definitely worth considering.
The other benefit involves something called a deficiency judgment. When a house is sold at auction, the chances of the foreclosing lender filing a deficiency judgment increases dramatically. As investors, we’re in the business of buying properties, but often the negotiation process used to achieve a short sale with the bank gives the homeowner their only shot at avoiding a deficiency judgment.
A quick review… As many of you know, a deficiency judgment is obtained when a property is foreclosed and sold (usually at the courthouse by the clerk of the court) to the highest bidder. In most states a deficiency judgment can be obtained for the difference between the high bid and the higher foreclosure judgment amount. Usually the court determines which value is higher, the high bid or the appraised value of the property on the date of the public sale. The higher of the two is taken to determine the difference from the judgment amount, and this difference is the deficiency judgment (what was owed subtracted by the final sale price).
Deficiency judgments are just that: judgments. They are an albatross around the neck of the debtor and can only be removed by paying it off or by bankruptcy. Furthermore, deficiency judgments usually earn interest until paid. In Florida right now that rate is 11% a year ––better than the bank by far!
If a homeowner is saddled with a deficiency judgment, guess what? They won’t be able to buy anything using credit. New house? Forget it. New car? Forget it.
While in the past we have seen few deficiency judgments filed against foreclosing homeowners, today that landscape has changed. We once were under the impression that banks seldom enforce deficiency judgments, which is true ––they sell the judgments for 5 to 10 cents on the dollar. Here’s the deal that the bank has to consider . . .for a $100,000 deficiency judgment they invest $500 in attorney fees and get $10,000 in return just for pushing paper. What do you think they are going to do?
For those unsecured promissory notes you negotiate on some of your deals, the same is true. The banks do the same thing –– getting 5 cents on the dollar.
Another point of consider, if the house goes into foreclosure and is taken back by the bank to be listed as an REO, the meter keeps running on the costs incurred by the bank until the REO dept. sells the house. This can make the deficiency huge.
Again, as investors we offer homeowners a way out. Whatever effect a short sale has versus a foreclosure on one’s FICO score pales in comparison to the long term harm of a deficiency judgment and the inability to be approved for a loan for years to come.
14 Comments to Short Sales and the FICO Score
These are some valid points. It’s been great to see that foreclosure listing prices (REOs) have been coming down faster, showing that banks are becoming more eager to sell off the property.
Hopefully banks will figure this thing out eventually. Otherwise they are just going to hurt themselves even more.
I loved the article it gave me all kinds of ammunition to tell people why a short sale is a good thing for them.
Thank you for the very timely, very awesome info! It will be much easier now to clarify the difference between the two choices to a person facing foreclosure–three years is a huge difference! Quantifying it this way, should make the decision clearer for someone when they’re deciding whether or not to do a short or let the bank foreclose.
Josh,
Thanks for posting the timely new Fannie Mae guidelines. I am writing to inform everyone that may not know about FICO scores and how they are reported.
As an investor that does short sales, I also am a rep for a credit restoration company.
Jerami in his/her post is incorrect (sorry), in their supposition that a short sale will result in less of a FICO score loss compared to a foreclosure on your credit report.
There is so much bad and incorrect information about the niche of short sales and credit restoration out “there” I just have to set the record straight.
Short sales are obviously the best alternative to a bad financial problem…by far this is better than a foreclosure.
The facts are thus: a short sale, (settled for less than owed), a foreclosure or a DIL, ( deed-in-lieu) are all considered and reported similarly…as a code # 22 from the credit repositories. The SS may or may not prevent a BK, but your credit suffers equally any way. A 150-200 FICO point reduction is about average.
I and a loan officer friend got into a big fight at a well known, but unnamed “short sales” forum, for having the nerve to question the Forum moderator’s information regarding this very subject.
They were just misinformed and ignorant. We are all ignorant of any subject until we learn how to do something. This means knowing all the facts…assume less until you have all the needed information.
Great info and thanks for the updates Josh!! The explanation about the deficiency judgement alone is enough to convince any homeowner as to the benefits of a short sale. More people need to know about this before just letting their houses blindly foreclose without doing anything…. Being armed with this kind of info is going to make all of us more marketable and helps others trust us even more. Very critical in our business since theres many fakes & scam artists….
Greta points and worth using to establish as a credible expert and to deter the just let it go syndrome. The points are obvious to us the investor but do not let that stop you from covering the points to the homeowner.
Mike from Mass
DougI want to see if I have this clarified.
So a deficiency judgment that is “negotiated off” of the homeowners responsibility through a Short Sale is the the PRIMARY benefit that the homeowner may receive beyond not having a “foreclosure” mark on their record.
They now OWE less or nothing in judgments, but their credit score is NOT more positively affected (points still knocked down the same) as having a Foreclosure, DIL or BK on the record?
If this is the case, the bottom line is it may not be good to over-stress the benefits of not having FC on their record, but rather the possibility of not having the Deficiency Judgment as well as a shorter time frame for re-establishing better/good credit.
Is this a good conclusion?
JeffGuys, we just listened to “death of the land trust” on your site. Thanks for posting that! We actually fit right into what you guys have said wasn’t going to be around very long. We use the trust (unrecorded), double close at 1st Am, using the end buyer funds, and closed 3 deals just last month. One of the 20k+ deals with one we thought would never close; small townhome, FHA loan (which we killed the BPO on, and closed it with an end users FHA loan in 84 days, start to finish)…Any comments? Our attorney is a great guy and is in bed with 1st am and their sen. Closer. I see the issues that can/will come up. I don’t ness. Have the correct option doc package and would like to use it. Where can I get it?
Jeff
We gave away the option contract paperwork as a bonus after the Death Of the Land Trust call a months ago but it’s no longer available as a free bonus. You can get for super cheap though. We have a few courses for sale in the market place. One is called the Short Sale Blueprint and One is called the Short Sale Money Machine. The Money Machine is only $79 bucks. includes 120 page course, 5 videos, 5 audios and all the “Option Contract” paperwork. I am not trying to make a sales pitch here but you can get all the documents you need plus a bunch of other cool stuff for 79$ dollars. @ http://www.shortsalemoneymachine.com
As far as your case study – FHA short sale, FHA end buyer using option contract? Or land trust? Once i know that i can comment in more detail.
Doug
Your conclusion is partially correct. NOT HAVING A DEF JUDGEMENT is huge b/c hopefully they can go get a loan quicker. If they have ajudgement on their credit then getting a loan of any kind would be impossible. The other thing is that having a Foreclosure on their report is terrible. Having a short sale is not great but much better than a foreclosure. The foreclosure will not let them buy a property for 5 years according to FNMA (FNMA and FDMC own 1/2 of the mortgage market) while a short sale may allow them to buy a property in a little as 2 years. The credit score may or may not be affected the same ( as far as drop in points) BUT having the FC on the report is much worse than the SS when it comes to the seller going to get a new loan in the near future.
Major points of this post
#1 short sale and Foreclosure may affect the credit score the same
#2 If they have a short sale vs. a foreclosure on their report the will be able to get a loan quicker (possibly 2 years vs. 5)
#3 Having a def judgement on their report will doom them for a long time b/c no one will give them a loan with a judgement on their report
#4 FNMA (and usually FDMC follows suit) will nto give someone a mortgage for 5 years with a FC on their report
#5 FNMA buy loans on the secondary market after the loan is originated. However the originator usually makes the loan knowing they are going to sell it to FNMA so they have to make sure they follow FNMA (and FDMC’s) guidelines when they make the loan otherwise FNAM will not buy it
I had no idea about the fannie mae time period for establishing credit after a short sale. Good to know. Jonathan Christopher of Short Sale Way
Leave a comment
Just enter your first name and email in the
box below for free immediate access!
Recent Posts
Categories
Awesome, thanks for reiterating these points. While it is impossible to accurately predict the point loss in a FICO, you can absolutely say that the loss will be less in a short sale versus a foreclosure.
This is by FAR the number one question I hear on a day-to-day basis.