Foreclosure Short Sales and the Tooth Fairy

For the last two years the real estate short sale has been a popular topic of conversation with investors as well as home buyers and sellers. Yes, but is the idea of a short sale much like kissing a frog with the hope it will turn into a handsome prince?

A short sale is when a bank or mortgage lender agrees to accept less than a homeowner still owes on a home. Lenders do that when there is not enough equity in the home to attract a buyer and pay all costs of a sale.

Ah yes, but a lender does not have to agree to a short sale and even with those that might consider cooperating it can be very difficult to make such deals work. That also makes home buying very difficult.

Banks have what's called a loss mitigation department that handles foreclosure short sales. As the economy moves into a recession those departments have been swamped with foreclosures and are often unable to respond to a short sale request before the home is lost to the foreclosure auction.

A real estate agent experienced with short sale deals might be able to help, but less than about 5% of defaulting homeowners are able effect a short sale before the foreclosure.

Oh, but there's more to it than that...

The big mortgage lenders package up their loans then sell them to investors all over the world. Sometimes the first buyer was Freddie Mac or Fannie Mae. They bought, packaged and sold millions of mortgage loans.

When a loan goes into default and a short sale is requested the lender needs to some how contact and negotiate with each investor who now owns a piece of the loan or loan package.

They ask Mortgage Investor #1 if he is willing to accept $X00,000?
They ask Mortgage Investor #2 if he is willing to accept $X00,000?
They ask Mortgage Investor #3 if he is willing to accept $X00,000?
They ask Mortgage Investor #4 if he is willing to accept $X00,000?

Maybe they can get in touch with everyone who owns a piece of the package and maybe not. Ah, but there's more...

Often there is more than one mortgage loan on the home and the negotiation process starts over again with those additional investors.

See the problem? With a short sale you not only have to negotiate with the investors, you have to negotiate with multiple lenders, sometimes as many as two or three. And they also must negotiate with their investors.

For homeowners facing foreclosure the question is should you even try for a short sale? Not an easy question to answer, but consider the follow:

A home owner's credit score will be damaged by going through foreclosure or by giving the home to the lender by means of a deed-in-lieu of foreclosure.

- Foreclosure or Deed-in-Lieu of Foreclosure

Sellers will take a credit score hit of something like 200 to 300 points. If before the foreclosure your FICO score was 680, it would drop as low as 380.

- Short Sale

Some say the hit on your credit score will be less with a short sale than a foreclosure. Others claim the damage will be identical. The short sale will appear as a "pre-foreclosure in redemption status" in your credit history. That may result in a credit score loss of 200 to 300 points. If your FICO was 720 you will see it fall to 520 to 420.

Are you doomed? If you have a foreclosure on your credit history will you ever be able to buy another home?

Sure you will IF you establish a good payment record with your other debts. After your foreclosure you might wait 24 to 72 months before a lender will offer a mortgage loan with a sensible interest rate. The more improvement you can show on your credit report the lower the rate of interest.

Most who have sold a home with the help of a short sale will be considered for new mortgage financing after two years if they show a responsible credit history. So the main advantage of a short sale is that you can be considered for a new mortgage loan within two years over the three- to five-year period required for foreclosures.

What about deficiency judgments? Are they going to squeeze you for every penny? Well, you could be subject to a deficiency judgment for the difference between the loan amount and the amount received by the lender in a short sale. Not to worry, many states have laws that no longer allow that and in the states that don't have such laws lenders seldom go to the expense of trying to collect from someone who apparently has no money.

Have you heard that you can be taxed on unpaid foreclosure debit? Forget it, because The Mortgage Forgiveness Debt Relief Act of 2007 generally allows you to exclude income from the discharge of debt on your principal residence.

Oh yes, since Washington has decided to bail out the banks they have little incentive to take less than what you owe them on any debit. Can you say, "Good bye short sales!"