Since 2008’s housing crisis and subsequent recession, the prevalence of homeowners going through foreclosure or short-sale on their homes has grown exponentially. Confusion remains, however, on the difference between foreclosure and short-sales, and the effects of each on one’s credit. The first hour of this week’s show aimed to address the distinction between the two and clarify the effects of each on one’s credit. The second hour continued with a more thorough discussion of credit scores as they pertain to the mortgage industry.
Many consumers, and even industry professionals, use “foreclosure” and “short-sale” interchangeably, when in fact they are two distinct things. The confusion stems from the fact that most homes going through foreclosure will eventually go through a short-sale. A homeowner can, however, short-sell their property without going into foreclosure. Foreclosure occurs when the homeowner is late on their mortgage payments; the lender exercises its right to call the loan balance due; and, barring the owner’s ability to repay the loan balance, the lender re-claims possession of the property’s title. The lender will then sell the property. If the sales price is less than the outstanding balance of the loan, this is a short-sale. Foreclosure is the disposition of the property; the short-sale is the process of selling the property.
As far as the homeowner is concerned, the primary difference between foreclosure versus a mere short-sale is that foreclosure typically releases the homeowner from the liability of paying off the full balance of the mortgage whereas a short-sale does not. If a homeowner elects to sell their home for less than the balance of their mortgage, they are liable for covering the difference. This difference is called the deficiency.
As far as creditors are concerned, there is virtually no difference between the two. A foreclosure and short-sale will have the same effect on a consumer’s access to future credit, particularly for home loans. Specifically. this means most lenders will not extend credit for a new home for another four years.
There are, however, ways to shorten this waiting period. Government loans such as FHA or VA, for example, require only three and two year waiting periods, respectively. For conventional loans, a down payment of 20% will shorten this period to two years, since the likely deficiency brought by foreclosure will be covered by that 20% down payment. In addition, the FHA adopted its “Back to Work Extenuating Circumstances” program in August of 2013 which provides foreclosure forgiveness for homeowners who can a) prove their foreclosure was the result of extenuating circumstances or hardships, such as job loss or severe market depreciation in their neighborhood, and b) show these extenuating circumstances have been remedied.
If you have gone through foreclosure or a short-sale in the last few years, it’s imperative that you understand your options so you’re better able to plan for the near- to mid-term future, and to take advantage of today’s unique market opportunities. As I’ve stressed in past shows, 2014 will likely be the last year in which it is cheaper to own a home than to rent. Further, you must assess your current credit profile so that you’re in the best possible position when it’s time to buy your next home.
Your first step should be to acquire a copy of your credit report from the three major credit bureaus: Equifax, Experian, and Trans-Union. These reports will show everything a creditor will see, such as delinquencies, accounts in forbearance, and dates of bankruptcies or foreclosures. It will also allow you to dispute any factual errors in these reports. These reports are available for free from the major credit bureaus; however, it’s recommended you pay for a report that will also provide your credit scores. The various bureaus use different models to derive a consumer’s credit score—using such data as length of established credits, number of inquiries, number of open accounts, late payments, bankruptcies, etc, and in varying proportions—and it’s nearly impossible to guess your credit score using only the information provided in the report.
Your second step is to assess your recovery. How far have you come since your foreclosure? And have the deleterious circumstances behind your foreclosure been remedied? Even if you’re past the 4-year, worst-case waiting period to take on a new mortgage, it’s unwise to do so if your financial situation is still precarious. You need to objectively step back, assess your finances, and decide whether you’re now ready to take on such a large liability.
The second hour of the show was positively stuffed with pertinent information regarding credit scores, reports, and profiles, so I highly recommend checking it out in the Jay Garvens Show archives if you weren’t able to listen live over the weekend. The last several years have been turbulent for many individuals, and it can be a long road to full recovery. But with the right tools and information regarding your credit profile and the options available for new credit or loan programs, you can not only shorten this road to recovery but also ensure that you’re in a stronger financial situation than before.
2-1-14 Your Credit Score
2-1-14 Short Sale