Is it better to give my house back to the bank or short-sale it? As a mortgage professional, I hear this question all the time from real estate agents and frightened homeowners.
It’s easy to be confused because loan guidelines and credit scoring algorithms change frequently – what’s true today might be different tomorrow. Adding to the confusion is the fact that many lenders impose more restrictive guidelines than those referenced below. Having said that, here is a basic guide for those facing short-sale or foreclosure:
Short Sales and Short Refinances
When a bank agrees to settle for less than the full amount owed on a loan, otherwise known as a “short sale” or a “short refinance” it will typically impact a your credit score by 50-150 points according to many credit experts. As a general rule, the higher your credit score starts out, the more of a hit it will take when you have a problem.
If a short-sale was due to financial mismanagement, you may not be able to qualify for another mortgage for up to two years on FHA or VA loans and four years on conventional loans. Under some circumstances, FHA will waive the waiting period entirely for those who do not get behind on their payments prior to the short-sale… however lenders are usually more stringent.
Foreclosures, Pre-Foreclosures and Deed-in-Lieu of Foreclosure
Sometimes a bank will agree to take the deed to the home in lieu of going through the foreclosure process. Credit experts say that both “Deed in Lieu” and actual foreclosures will typically impact a your credit scores by 50-250 points.
If a foreclosure was due to financial mismanagement, you may not be able to qualify for another mortgage for at up to two years on VA loans, three years on FHA loans and four years on conventional loans. A deed in lieu of foreclosure has slightly relaxed conventional guidelines, only requiring a two year wait.
The waiting periods listed above might be shortened if you can prove extenuating circumstances, but these are difficult to qualify for. Job loss, relocation, divorce or decline in value do not typically qualify as an extenuating circumstance. Furthermore, the waiting periods might be longer if it appears that a borrower orchestrated a “strategic default.”
Homeowners should be aware that some lenders will pursue a judgment for any deficiency balance owed after a short-sale, foreclosure, or deed in lieu of foreclosure. If this happens, it opens a whole new can of credit and mortgage worms.
Could you get stuck with a big tax bill as a result of a short-sale or foreclosure? Prudent homeowners will consult a tax accountant about possible tax ramifications because the Mortgage Forgiveness Debt Relief Act does not apply to every situation.
What’s the good news? If a mortgage default cannot be avoided, then homeowners should remember that isolated credit issues are better than multiple or ongoing issues and your credit scores will slowly recover over time. After seven years most derogatory information will drop off your credit report entirely and it’s never too early to start rebuilding good credit! For additional information on these and other credit issues, you can click here for a chart that will help you understand how major credit issues impact your ability to purchase a home in the future.