Short Sale vs Foreclosure: Which Pill to Swallow?

Being a homeowner today is not easy, unless you own your home outright. For most that make mortgage payments, even if you have sufficient funds to make payments regularly, declining property values have crippled re-financing as a viable option. If you are a distressed home owner and have lost income and can’t make mortgage payments, you can either surrender to foreclosure, whereby the bank or loan company takes legal action to take total control of the property or you can attempt a short sale, whereby the bank agrees to accept less than the total amount owed on a mortgage to avoid having to foreclose on the property.

Being foreclosed has severe consequences to one’s reputation and credit. Participating in a short sale also has consequences, but they are less severe than those associated with foreclosure.

The following compares and contrasts some life options if you do a short sale vs. being foreclosed.

Buying Again: Short Sale vs. Foreclosure

If your payments have never fallen behind 30 days late and the lender does not require that you pay back the loan, Fannie Mae guidelines may allow you to buy another home immediately. Finding a lender who will fund that kind of loan is very difficult. If you are current on your mortgage, you can qualify for an FHA loan immediately as well, but lender requirements can be weird such as you have to move more than 600 miles away.

If your payments are in arrears yet a short sale is granted by your lender, you may qualify to buy another home with a Fannie-Mae backed mortgage within two years, regardless of whether the home is your primary residence. The wait for FHA is 3 years.

With certain restrictions, you may be eligible, after having your home foreclosed, to buy another home in 5 years if the home was your primary residence. Without restrictions, the wait is 7 years.

If you are an investor and do not occupy the home, the wait to buy with a Fannie Mae insured loan is 7 years.

Affects on Credit: Short Sale vs. Foreclosure

A short sale may be considered to be a derogatory mark on your credit even though credit bureaus do not show the word "short sale" on your credit report. It may say "paid in full for less than agreed" or "settled for less," among other categories. Some clients have reported negative FICO score drops from 50 points to 130 points.

Major point drops are typically due to being in default, meaning you have fallen behind on your payments.

Depending on your credit history and other guidelines, a credit score could fall 105 points to 160 points after a foreclosure. Generally, a foreclosure will remain on your credit report in the tradelines section for 7 years.

Credit Reports: Short Sale vs. Foreclosure

All lenders report short sales differently, with many reporting "paid in full for less than agreed," and some report the short sale as a charge off. Negative credit, however, stays on your report for 7 years. If a prospective employer runs a credit check on you, your job application may be denied if you have a foreclosure on your record.

Deficiency Judgments: Short Sale vs. Foreclosure

Judgments are often negotiated between the seller and the short sale bank. In some cases, such as California, if the home is your personal residence and was financed through purchase money, there is no deficiency judgment. Banks are generally unwilling to negotiate deficiency judgments with the homeowner after a foreclosure. In California, for example, according to the California Association of REALTORS, a deficiency judgment may be filed regarding a hard-money loan if the lender forecloses under a judicial foreclosure versus a trustee sale or if the second loan is a hard money loan and the sale takes place as a trustee's sale.

Loan Application Questions: Short Sale vs. Foreclosure

Loan applications do not ask questions about a short sale. You may report that you sold your home. However, you are required to answer the question: "Have you ever had a property foreclosed upon or given a deed-in-lieu thereof in the past 7 years." If the bank sees you have had a foreclosure, your loan most likely will be denied. If you lie, you may be subject to investigation by the FBI for mortgage fraud.

Length of Time to Move:  Short Sale vs. Foreclosure

If you've had a foreclosure notice filed, you may be able to postpone that action while the bank considers your short sale. The wait for short sale approval can be from 2 to 3 months, or longer. Unless prior arrangements have been made, the bank may want you to immediately vacate the property and can commence eviction proceedings.

Taxation: Short Sale vs. Foreclosure

A personal residence is exempt from mortgage debt relief until the end of 2012 on a federal level. Some states will still tax you unless you qualify for an exemption. An investor is not exempt from mortgage debt relief, subject to certain conditions.

A person who has had their home foreclosed, is protected under the mortgage debt relief act that is in place until the end of 2012. Nevertheless,  some lenders immediately send out 1099s, even if the owner is exempt.

Going for a Short Sale: Time is of the Essence

To qualify for a short sale your home must be worth less than you owe on it, and you  must be able to prove that you are the victim of a true financial hardship, such as a decrease in wages, job loss, or medical condition that has altered your ability to make the same income as when the loan was originated. Divorce, estate situations, etc… also qualify.

As a seller of a property you should never have to pay for any short sale cost upfront to any professional service. Realtors charge a commission that is paid for by the bank. In most communities there are also non-profits and HUD counselors who can help you with foreclosure prevention options for free. The only potential cost you could incur is if the bank would not release you from a deficiency balance in the short sale, which is happening less and less now.

The farther you get behind on your payments, the harder it is to get a short sale approved. The closer a property gets to a foreclosure the harder it is to convince the bank to perform a short sale; as they get closer to a foreclosure sale more money is spent, thus deterring them from doing a short sale.

If you think you need to perform a short sale, time is of the essence; the sooner you start the process, the better. Waiting too long can trigger the ramifications of a foreclosure, rendering the short sale unviable.

5 Tips to Help you Qualify for a Loan in Today's Economic Climate

If you have a weak credit score, a history full of late payments or you owe a significant amount on credit cards and elsewhere, you're unlikely to get a green light for a mortgage. You can also be denied if your credit profile changes in mid-process of submitting your application for a mortgage loan. Other conditions to recognize as obstacles to securing a mortgage loan include consistently making only the minimum payments on your debt and opening  a number of new credit lines in a short period of time.

Here are 5 basic tips to help you get your financial house in order when shopping for a new home: 

1. Get rid of as much debt as possible before starting the mortgage application process. You need an established payment history to get approved for a mortgage and the best interest rates. If you have a recent late payment - or you've just paid off some delinquencies, allow at least six months before starting to apply for a loan. 
2. Reduce your overall debt-to-income (DTI)  ratio and improve your credit score. Lenders typically look for a borrower’s total monthly expenses to not exceed 28% of their monthly gross income. Ideally, your monthly debt payments should be at most 12% of your income – the lower, the better. After obtaining  a mortgage, of course, your DTI ratio climbs significantly, but shouldn't be higher than 43% of your income.
3. Clean up your credit. First, find out your credit score. Obtain a report from each of the three credit bureaus and carefully review them for  all negative items. Address any and all inaccurate or old notations. Your score needs to be a minimum of 680 -- preferably 720 or higher -- to qualify for a lower interest rate on a mortgage.
4. Hold off on large credit purchases, and don't apply for any new credit until you close. Lenders check credit reports at the time you apply and then again right before closing. 
5. Get your paperwork together. A lender will want to see pay stubs, bank statements, assets, credit documents, income tax returns, all financial statements. How far back should you go? Expect to show the last five years, and possibly more. Whatever you provide the lender, be sure to make copies to retain for your own files.

Home mortgage loan rates are relatively low historically, but today, lenders have high expectations for those to whom they will loan money. Gone are the zero-down home loans of the previous decade. Obtaining an affordable mortgage requires, in today's environment, more work than ever on the part of the borrower. But the result of a new home at a great mortgage rate is worth the effort.

The Misinformed Home Buyer: The Missing Link in a True Real Estate Recovery

What’s the real truth regarding whether or not the real estate industry has officially recovered?  Hopeful optimism from real estate professionals, industry analysts and the government paint a promising picture of the road ahead.  To be sure, their sentiments have quantifiable merit.  Government intervention through a host of programs targeting distressed borrowers is now gaining traction. Banks and servicers are now more amenable to short sales and principal reductions than at the beginning of the crisis. Rumor has it that in selected U.S. markets, home values have hit the proverbial bottom and the words “positive equity” have been uttered.   The industry and the media point to these and many more accomplishments over the past two years to validate their positions that a recovery is actually, truly, here.  However, the prevailing reports of a turnaround in real estate exclude the one segment required to balance the equation signaling once and for all that “the light at the end of the tunnel” is no longer a convenient platitude: the first-time and previously-distressed homebuyer has been redacted from the picture as a result of widespread misinformation regarding their ability to join the party.  And without the mainstream buyer as part of the mix, reports of a real estate recovery lack the credibility they need.

Simply put, mainstream buyers are having a hard time separating fact from fiction when it comes to obtaining a mortgage for an affordable home.  The real estate industry and its pundits, by lauding its attention on the “low hanging fruit” that represents stability and growth in the housing sector, are sending the wrong message to a potentially large group representing the next wave of home buyers. Here are just a few examples:

• “All-cash buyers snapping up deals” interpreted by mainstream buyers as “I can only find an affordable home if I buy it outright.”
• “Banks are utilizing stricter underwriting standards to qualify” interpreted as “Why bother – banks aren’t lending.”
• “The average FICO score for an approved loan is 700-720 interpreted as “My FICO score is too low.”
• “Homeowners who have been foreclosed on or lost their home in a short sale are ‘distressed’” interpreted as “’Once distressed always distressed’ can never own a home again.”
• “America is becoming a nation of renters” interpreted as “There’s no real value in owning a home.”

What’s the truth?

• All-cash buyers comprise approximately one-third of real estate sales.  Buyers with financing already in place can compete, and real estate needs a diversified source of buyers to truly experience recovery.
• Granted, extremely lax underwriting standards contributed to the mortgage meltdown of the last cycle.  However, lenders have taken corrective steps to guarantee borrowers can truly afford the mortgage they seek, and they are now feeling more confident to allow guarded flexibility into the underwriting guidelines to enfranchise more borrowers.
• Lenders offering FHA –backed loans and other specialized loan products consider factors other than just a FICO score to qualify borrowers for a loan.
• Credit, along other criteria required to obtain a mortgage, can be rebuilt in a shorter time frame than prospective borrowers would imagine.
• More and more markets are emerging across the country where the divide between the cost to rent and the cost of a mortgage to buy a home is narrowing as a result of rising rents and affordable home prices.

Armed with more accurate information, prospective mainstream home buyers can get a seat at the head of the table to contribute to the real estate recovery.  The real truth is that there won’t be a legitimate recovery without an environment of healthy demand that can only be generated by buyer source other than investors.  First-time and previously-distressed buyers that understand that home ownership is still possible when properly informed about their options, is the final ingredient  to make speculation about a real estate recovery indisputable fact.  

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Kirk Jaffe is Executive Vice President, Originations for Peak Finance Company - Residential. Jaffe oversees the consistent growth of a mortgage broker/banker and asset based lender. Through his expertise in commercial, residential and asset based lending, Jaffe seamlessly integrates these areas into a one stop financing solution for homebuyers and property investors.


Mr. Jaffe is the publisher of two books and is the residing President of the Universal City/North Hollywood Chamber of Commerce. In his spare time, Mr. Jaffe enjoys cooking, skiing and reading.


Kirk can be reached at kirk@peakcorp.com

To Stimulate the Housing Cycle - Change the Psychology of the Consumer

Prevailing sentiment suggests that the concept and economic drivers supporting homeownership as part of American households’ financial strategy has waned. Downward pressure on home prices resulting from high concentrations of distressed properties affecting values, combined with constrained credit, has affected that once-dependable cycle of household migration. Where once entry-level prospective homebuyers had a competitive selection of product made available by existing homeowners selling homes to move up to more affluent housing, cycle movement has been frozen because that middle market homeowner either doesn’t have sufficient equity or credit to move. Further dampening the normal progression of the cycle is a younger, more transient generation complacent to rent.

The question is where is the next wave of homeowners coming from to restore equilibrium in the housing market? The answer – the same younger generation, currently content to rent, and the middle-market household lacking the confidence to shoot for a larger home, will provide the buying power that will lead to positive market shift. The secret in moving the cycle lies in changing the psychology of these consumers.

For example, the “psychology” of the typical millennial (content to rent) household is obviously influenced by today’s new economy that tells them renting today is more sensible than owning. The concept of residential real estate as an asset has been displaced in this segment’s mind by news of millions of borrowers underwater with mortgages, and falling home values. The middle-market homeowner’s mindset, also viewing the negative aspects of the current market is preventing that segment from “moving up.” Both millennial and middle-market owners could be deceiving themselves. Here’s why:

Using the example of an average millennial couple with an annual gross income of $75,000 paying $1,000 toward rental housing compared to a monthly mortgage of $1,500, the couple would expect to see equity of approximately $21,422 over a 5-year period when they buy a home valued at $250,000. (This assumes a 30-year fixed mortgage at 4.5% with 3% down payment, and would hold true in either a stagnant or appreciating home market.) Even given the transient nature of today’s younger households, after just 2 years, the couple could expect to see $8,004 in equity compared to $25,560 they would have paid in rent with nothing to show in return for that money. In addition, borrowers should expect to see tax benefits resulting from the current, existing IRS mortgage interest deduction rules.

For existing homeowners, there are several sentiments to overcome. Concerns about equity position on the sale of their current home as well as trepidation about the ability to qualify for a new home mortgage can discourage current homeowners from pursuing their interest in “moving up.” The truth is, move-up homeowners are just as capable of reaching their goals today as they were several years ago. With mortgage rates at historic lows, and property affordability at higher levels, homeowners who desire to move up only need to speak to their CPA or an experienced loan agent who will run the numbers to see how the money they’re spending on their current mortgage could actually buy them “more house.”

For the cycle of home ownership to return to a fluid state where buyers at all levels are able and willing to participate, a major shift in thinking is required. This shift can be achieved by educating both new generation buyers and established homeowners on how the current real estate landscape does, indeed, provide opportunities to achieve the American dream regardless of where they are in their life cycle.

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Kirk Jaffe is Executive Vice President, Originations for Peak Finance Company - Residential. Jaffe oversees the consistent growth of a mortgage broker/banker and asset based lender. Through his expertise in commercial, residential and asset based lending, Jaffe seamlessly integrates these areas into a one stop financing solution for homebuyers and property investors.

Mr. Jaffe is the publisher of two books and is the residing President of the Universal City/North Hollywood Chamber of Commerce. In his spare time, Mr. Jaffe enjoys cooking, skiing and reading.

Kirk can be reached at kirk@peakcorp.com.