Foreclosure VS. Short Sale
Distressed Property Defined
The definition of a distressed property is:
1. A property that is in poor physical condition
2. A property that is or soon will be in some stage of the foreclosure process
3. A property owned by a person or persons who are experiencing a period of financial instability
4. A property on which the mortgages total an amount higher than the current value and the owner must sell
A Realtor who has earned the Certified Distressed Property Expert
Designation (CDPE) and has dedicated their time and effort to
understanding the issues distressed homeowners are dealing with. The
CDPE Professional understands the full range of solutions and is ready
to help.
The developers of the CDPE Designation believe that in almost all cases the best person for a homeowner in distress to speak with is a well informed Licensed Realtor that has the tools needed to help that homeowner find the best solution for their situation.
While experiencing financial distress is difficult for any family, the process of finding a real estate professional shouldn’t be. Selecting a CDPE Realtor ensures you are dealing with a professional ready to address your needs.
We are here to help, and will use the utmost discretion!
A hardship can be defined as:
A material change in the financial situation of a homeowner that is or will affect their ability to pay their mortgage
You must have a hardship in order to qualify for a short sale. Examples of acceptable financial hardships are:
· Payment Increase or Mortgage Adjustment
· Loss of Job
· Business Failure
· Damage to Property
· Death of a Spouse
· Death of Family Me not actually divorcing, the
cost of maintaining two households can cause the loss of a primary residence.
Relocation
Homeowners do not always have control over where they live; many relocations
are
necessities not choices. This can quickly cause unexpected distress
since very few homeowners can support two households for any significant
length of time.
Military Service
Except for the relief provided by very specific situations by the Service Members
Civil
Relief Act (SCRA), military service can lead to unexpected financial
issues. Service members who have had their periods of active duty
extended are suffering a tremendous amount of financial pressure.
Insurance or Tax Increase
For many homeowners just the increase in taxes on an annual basis or the increase
of an insurance payment can cause a family to lose a home or go into financial distress.
Reduced Income
If a person is in a commission based business (like most sales jobs) and the
economy
suffers, often times their income suffers. Also many businesses are
reducing employee compensations to make up for lost revenues that
corporations have suffered.
Medical Bills
The high cost of medical treatment can quickly cause a family to go into financial
distress. Especially because it usually is accompanied by time off from work.
Too much debt
For a family with credit card debt, even minor increases in their interest rates can
make the difference between paying all their bills and missing payments.
Incarceration
If an individual or family member is incarcerated a financial distress can occur.
Reinstatement
This is where the homeowner reinstates the mortgage by paying up all missed
payments and fees and becomes current with the mortgage. After all the fees have
been paid up, the homeowner can continue to pay the mortgage payments as they had.
Forbearance
More commonly known as a re-payment plan, allows the homeowner to negotiate a
repayment of missed payments and fees to reinstate the mortgage.
Sell the Property
If there is equity in the property then the home can be sold and the foreclosure can be
“cured” thus avoiding the foreclosure. If the home is worth less than is owed plus
sales expenses then a short sale must be negotiated (See the section on “Short Sale
Explained”).
Rent the Property
The property can be rented, however, the mortgage must be made current. A rental
agreement will not stop the foreclosure process.
Refinance
If the credit rating hasn’t been too badly damaged, a refinance may help especially if
the monthly payments can be reduced.
Deed-in-Lieu of Foreclosure
Commonly known as the friendly foreclosure, this involves for the bank to agree to
foreclosure and take the property back without the lengthy process. This is not
recommended for properties with equity because the owner gives up the right to the
property and any equity. This option is technically still a foreclosure and will show up
as such on your credit report. Sometimes the bank will forgo any other recourse but
that will also have to be negotiated.
Bankruptcy
It cannot avoid the foreclosure but may allow the owner to reorganize debt and stall
the foreclosure. Another drawback is that it makes it difficult to sell the property and
almost impossible to negotiate with any third parties.
Short Sale
When the homeowner owes more than the property is worth plus sales expenses, a sale
can be negotiated and an approval obtained from the bank to accept an amount less
than is owed.
Most
of the options above involve negotiation with the bank and a decent
credit rating. If the credit has been affected already, then the only
real option that can help is the short sale.
Texas Foreclosure Law Summary
- Judicial Foreclosure Available: Yes
- Non-Judicial Foreclosure Available: Yes
- Primary Security Instruments: Deed of Trust, Mortgage
- Timeline: Typically 60 days
- Right of Redemption: No
- Deficiency Judgments Allowed: Yes
In Texas, lenders may foreclose on deeds of trusts or mortgages in default using either a judicial or non-judicial foreclosure process.
Judicial Foreclosure
The judicial process of foreclosure, which involves filing a lawsuit to obtain a court order to foreclose, is used when no power of sale is present in the mortgage or deed of trust. Generally, after the court declares a foreclosure, the property will be auctioned off to the highest bidder.
Non-Judicial Foreclosure
The non-judicial process of foreclosure is used when a power of sale clause exists in a mortgage or deed of trust. A “power of sale” clause is the clause in a deed of trust or mortgage, in which the borrower pre-authorizes the sale of property to pay off the balance on a loan in the event of their default. In deeds of trust or mortgages where a power of sales exists, the power given to the lender to sell the property may be executed by the lender or their representative, typically referred to as the trustee. Regulations for this type of foreclosure process are outlined below in the “Power of Sale Foreclosure Guidelines”.
Power of Sale Foreclosure Guidelines
If the deed of trust or mortgage contains a power of sale clause and specifies the time, place and terms of sale, then the specified procedure must be followed. Otherwise, the non-judicial power of sale foreclosure is carried out as follows:
1.
Prior to proceeding with a foreclosure, Texas laws state that the
lender must mail the borrower a letter of demand, informing the buyer he
has twenty (20) days to pay the delinquent payments or foreclosure
proceedings will begin.
2. At some point after the borrowers twenty
(20) days have expired, but at least twenty one (21) days before the
foreclosure sale, a foreclosure notice must be: 1) filed with the county
clerk; 2) mailed to the borrower at their last known address; and 3)
posted on the county courthouse door.
3. The foreclosure sale must
take place on the first Tuesday of any month, even if said Tuesday falls
on a legal holiday, but only after the proper preliminary notices have
been given. The sale is on the courthouse steps by auction to the
highest bidder for cash. Anyone may bid, including the lender, who bids
by canceling out the balance due on the note, or some part of it.
Lenders
may obtain deficiency judgments, but they are limited to the difference
between the fair market value of the property at the time of sale and
the balance of the loan in default.
|
ISSUE |
FORECLOSURE |
SUCCESSFUL SHORT SALE |
|
Future Fannie Mae Loan Primary Residence (Effective 5/21/08) |
A homeowner who loses a home to foreclosure is ineligible for a Fannie Mae backed mortgage for a period of 5 years. |
A homeowner who successfully negotiates and closes a short sale will be eligible for a Fannie Mae backed mortgage after only 2 years. |
|
Future Fannie Mae Loan Non Primary (Effective 5/21/08) |
An investor who allows a property to go to foreclosure is ineligible for a Fannie Mae backed investment mortgage for a period of 7 years. |
An investor who successfully negotiates and closes a short sale will be eligible for a Fannie Mae backedinvestment mortgage after only 2 years. |
|
Future Loan with any Mortgage Company |
On any future 1003 application, a prospective borrower will have to answer YES to question C in section VIII of the standard 1003 that asks “Have you had property foreclosed upon or given title or deed in lieu thereof in the last 7 years? This will affect future rates. |
There is no similar declaration or question regarding a short sale. |
|
Credit Score |
Score may be lowered anywhere from 250 to over 300 points. Typically will affect score for over 3 years. |
Only late payments on mortgage will show and after sale mortgage will be reported as paid or negotiated. This will lower the score as little as 50 points if all other payments are being made. A short sale’s affect can be as brief as 12 to 18 months. |
|
Credit History |
Foreclosure will remain as a public record on a person’s credit history for 10 years or more. |
A short sale is not reported on a credit history. There is no specific reporting item for ‘short sale’. The loan is typically reported ‘paid in full, settled’. |
|
Security Clearances |
Foreclosure is the most challenging issue against a security clearance outside of a conviction of a serious misdemeanor or felony. If a client has a foreclosure and is a police officer, in the military, in the CIA, Security, or any other position that requires a security clearance in almost all cases clearance will be revoked and position will be terminated. |
A short sale on its own does not challenge most security clearances. |
|
Current Employment |
Employers have the right and are actively checking the credit regularly of all employees who are in sensitive positions. A foreclosure in many cases is grounds for immediate reassignment or termination. |
A short sale is not reported on a credit report and is therefore not a challenge to employment. |
|
Future Employment |
Many employers are requiring credit checks on all job applicants. A foreclosure is one of the most detrimental credit items an applicant can have and in most cases will challenge employment. |
A short sale is not reported on a credit report and is therefore not a challenge to employment. |
|
Deficiency Judgment |
In 100% of foreclosures (except in those states where there is no deficiency) the bank has the right to pursue a deficiency judgment. |
In some successful short sales it is possible to convince the lender to give up the right to pursuit a deficiency judgment against the homeowner. |
|
Deficiency Judgment |
In a foreclosure the home will have to go through an REO process if it does not sell at auction. In most cases this will result in a lower sales price and longer time to sell in a declining market. This will result in a higher possible deficiency judgment. |
In a properly managed short sale the home is sold at a price that should be close to market value and in almost all cases will be better than an REO sale resulting in a lower deficiency. |
1.
You will always have to disclose that you have had a foreclosure on any
mortgage application and many job applications you submit in the future
and this can have an adverse affect on your future mortgage rates. This
is the only credit item that is asked specifically and does not rely on
what is on an individual’s credit report.
2. Your credit scores
will be lowered by 300+ points and a foreclosure is the most devastating
credit issue you can have in relation to future credit availability.
3. A foreclosure is the one credit report item that is almost impossible to have “repaired”.
4. Your lender can seek a deficiency judgment against you and collect for any amount they do not recuperate at bank sale.
5.
Many employers run credit checks on prospective employees and
foreclosure is one of the top items that will put you as a potential new
hire in jeopardy.
6. Many current employers run credit checks and a foreclosure can put a current position in jeopardy.
7.
Security clearances and government positions including but not limited
to military and law enforcement can be jeopardized by a foreclosure.
8.
You may be responsible for any deficiencies after foreclosure for an
indeterminate period of time depending on the state you live in; this
can land a homeowner in never ending collections.
9. “As your Certified Distressed Property Expert agent we will explore every option with you and work toward a resolution.”
10. “While
it may not seem like it now, there will come a time where your current
financial troubles will pass. You will feel much better knowing that you
did everything you could to avoid this devastating financial
consequence so many people face today.”
A short sale is a phrase used to describe a sale in which the cost of the product or service being sold is actually more than the sales price of the product or service in question. Another common term to describe a short sale is being "upside down". The term short sale has become synonymous with any real estate transaction where the lender is agreeing to accept an amount less than is owed. There are other variations of the meaning of short sale but for our purposes we will only discuss real estate transactions.
In real estate, a short sale is a rather lengthy process in which an agreement is made between the bank and seller for the bank to accept a lesser amount than owed. The typical steps in the process are as follows:
Short Sale Process
The seller needs to be in a distressed state, most of the time the property is in foreclosure. If a homeowner is current on mortgage payments the bank will not always approve a short sale. The loan is said to be "performing". This is rapidly changing and nowadays banks are willing to negotiate with even "performing" loans.
A lengthy package of documents needs to be assembled to prove to the bank that the seller can no longer make payments. Most of these documents are the same ones used to qualify for the loan. You are basically disqualifying the property owner. In addition to those financial documents a hardship letter needs to be drafted explaining what caused the financial hardship. Also market trend reports, recent sales, market analysis, news clippings and other information that can help the bank make a better determination as to why they should accept a short sale should be included.
The property has to be put on the market for sale and one must show a concerted effort to sell the property at market value. There is misinformation out there where people believe the bank will accept any amount. This is not true. The bank will only accept market value whatever it may be. A detailed record of activity needs to be kept and submitted to the bank along with all the other documents.
Once a buyer is found, the purchase contract along with all the documents already mentioned, is submitted to the bank for approval. Once approved, the sales process is continued as any normal real estate transaction would.
Most homeowners don't know that the bank will pay almost all required fees and commissions to all parties on behalf of the seller. Essentially the homeowner walks away paying nothing. The exception being that the bank may require an appraisal in which case the homeowner might be asked to pay for it. Sometimes when back dues or assessments are owed to a homeowners association, the homeowner is also asked to pay for some of those fees. Also important to note, in no case may the homeowner walk away with any proceeds from a short sale. In some extreme cases you may negotiate with the bank for the homeowner to receive a small amount (usually no more than $1500) for moving expenses and help with rent. Again this is rare and not the norm.
After a short sale has been successfully negotiated, the shortfall can be dealt with in various ways by the bank. These are the most common methods used by the bank to recoup losses.
Deficiency Judgment
A deficiency judgment is sought by the bank in order to recoup losses. A judge usually grants these fairly easily. However the judgment itself only gives the bank the right to recoup the monies, the process itself has to be undertaken by the bank. This gets expensive and most times they seek the judgment just so they have the flexibility to go after the homeowner in the future. Statute of limitations is typically two years to exercise this option. What has been happening as of late is that the banks are so overwhelmed that they file for the judgment and little else.
1099
Another option the bank has is to issue a 1099. A 1099 is an IRS form alerting the IRS that the homeowner has profitted from a short sale. That amount that the bank was shorted is treated as a profit to the homeowner. The bank may issue a 1099 or file for a deficiency judgment, they cannot do both. (Important note: This provision in the tax code has been suspended for short sales involving primary residences through tax year 2009.)
Unsecured Note
The bank can also negotiate to issue an unsecured note in the amount of the deficiency. This is similar to a credit card or personal loan not collateralized by anything. This is purely an accounting trick in order to give the illusion of getting bad debt off their books. They never expect to see a dime of this loan but it looks good on the balance sheet to investors when a bad mortgage is replaced by a successful sale and another "performing" loan. Did I hear someone say Enron?
Payment in Full
Last but not least is negotiating with the bank for payment in full. Although this sounds impossible, it does happen fairly regularly. The bank is all too happy to put this expensive endeavor behind them as well. This should always be the goal of any short sale negotiations.
2 Years VS. 10 Years
Your credit will be marred whether you decide to let the bank foreclose or the property is sold via a short sale. However you can begin effective credit rating recovery after 2 years with a short sale. A foreclosure will adversely affect your credit score for up to 10 years. Often times after a foreclosure the homeowner has to file for bankruptcy, the proverbial double whammy.
50 Points VS. 300 Points
A short sale can shave as little as 50 points off your credit score. Only the late payments are reported. A foreclosure will take 300 points off for each loan foreclosure. Properties with 2 mortgages can see the owner lose up to 600 points off their credit score. You can see why with a bankruptcy filing, soon follows a foreclosure.
