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Homeowners who are struggling with their mortgage payments have several options. Two of those options are a short sale and foreclosure. With a short sale, you get permission from your lender to sell your home for less than you owe on the mortgage. With a foreclosure, the lender seizes the home and sells it at auction.
Whether you should make a short sale or let a home go to foreclosure depends on several factors. For example, you may be able to buy your next home sooner with a short sale than a foreclosure.
While for some homeowners, it is easier to throw up their hands and let the bank take the home, that might not be the wisest thing to do.
Regardless of which approach you choose, always obtain legal and tax advice before deciding. If you sold your home as a short sale due to extenuating circumstances, you can reapply for a Fannie Mae-backed mortgage after two years with appropriate documentation of the circumstances.
Freddie Mac has similar requirements. You may also qualify for an FHA loan one year after a short sale. Bear in mind that Fannie Mae and FHA guidelines are not a guarantee you will be able to buy a home after suggested timeframes. Banks have the final say and often include overlays that can change the guidelines set forth by the government. If your foreclosure was due to extenuating circumstances, you may be eligible to buy another home backed by Fannie Mae or Freddie Mac in three years.
Otherwise, the standard waiting period remains seven years. Similar to its short sale guidelines, FHA allows those who foreclosed on their homes to apply for a new mortgage after 12 months. A deficiency judgment is when you're required to pay the difference between what the home is sold for and your mortgage balance. Judgments are often negotiated between the seller and the short sale lender. In some states, 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. Loan applications typically do not require you to include information about short sales. You are, however, required to note if you've ever had a property foreclosed or given a deed-in-lieu thereof in the past seven years. If the lender sees you have had a foreclosure, your loan may be denied.
A short sale is a transaction in which the bank lets the delinquent homeowner sell the home for less than what's owed. The borrower finds an agent and puts the house on the market, often at a substantial discount. The hope is that, if the home sells, the lender will recoup the majority of what the homeowner owes. This saves the lender the expense of a foreclosure suit and the possible long-term cost of owning a hard-to-sell foreclosed home [source: Foust ].
A short sale doesn't absolve the borrower from the debt he or she incurred with the original mortgage , but it can be better than a full-on foreclosure. Let's take a look at 10 reasons why a short sale may present a better option than letting your home slide into the long, draining process of foreclosure.
From a lender's perspective, it's better to recover a portion of a mortgage loan than to absorb a total loss. Therefore, in lieu of a foreclosure , banks will often settle for a short sale. This allows both the lender and the homeowner to end up in a better position. One concern for many homeowners, however, is whether the bank will sue for a deficiency judgment after foreclosure. In an attempt to recover the difference in the amount that was paid and the amount of the loan, the bank can file a lawsuit against the homeowner.
A deficiency judgment will appear on a homeowner's credit report and have a negative impact, just as a foreclosure would [source: Experian ]. But rather than endure a costly and possibly lengthy litigation process, a bank will often cut its losses with homeowners who are unable to pay their mortgages due to a proven hardship, such as a divorce or loss of income.
And the reduced amount of money owed will ease the burden on the homeowners and not irreparably damage their credit. A foreclosure on a home adversely affects the homeowner in a number of ways, and it also has a negative effect on the lender and the housing market in general. The homeowner receives a mark on his or her credit that can make it difficult -- sometimes impossible -- to borrow money for another home, car or major purchase.
This can essentially remove the former homeowner from the pool of large-purchase consumers, a key part of the nation's economic engine, for years. Banks nearly always lose money on foreclosures; between the lower sale price they receive at auction and the resources they must assign to administer the foreclosure process, it's rare for them to come out ahead at the end of a foreclosure [source: Experian ].
The housing market also suffers from foreclosure, due to decreased home values. A report by the Federal Reserve Bank of Cleveland estimated that a foreclosed home not only dropped in value, but caused homes within a foot radius to lose up to 1 percent of their value, as well [source: Hartley ]. Foreclosed homes are less likely to be maintained and more likely to remain on the market for an excessive period of time, and they make it difficult for homeowners with good credit to upgrade into more expensive homes.
Congress Joint Economic Committee. Add in the additional costs that can accumulate throughout the sometimes lengthy foreclosure process, which could be just the tip of a burdensome financial iceberg.
And if the homeowner is unable to afford payments, the foreclosure could eventually lead to a financial situation where bankruptcy -- with its significant credit implications for the borrower and costs for the lenders -- is the only option [source: Christie ].
Mortgage lenders won't always file for a deficiency judgment in a foreclosure case. It depends on the situation and the likelihood that they can win back the amount owed on the property. However, if all sides agree on a short sale , a new buyer in a better financial state could absorb some of what the original homeowner owes the lender. This would ease the original homeowner's hardship and put him in a more manageable position [source: Foust ].
Likewise, a short sale can drastically reduce the amount a bank may be looking to recoup from the homeowner. As we mentioned, a lender is also negatively affected by a foreclosure. After the cost -- and time expense -- of sending multiple notices and warnings to a delinquent homeowner, the lender faces additional costs as the foreclosure moves into the courts.
Legal filings, hearings and the associated documentation all take time and money to prepare. After the foreclosure sale, the lender may sue to recover money that's owed above the amount that a home was sold for in a foreclosure, adding to legal costs. Also, since the lender gains ownership of the property, the lender faces the expenses and dilemmas every homeowner faces when selling a property: If it takes time to sell, it can become a very expensive burden.
Even if the sale doesn't stretch on, the lender must still hire a real estate broker to administer the sale of the house [source: Foreclosure. However, in opting for a short sale , the lender can recover a portion of the money that's owed on the property, thus reducing the loss without the extensive legal process of a foreclosure. In many cases, a short sale reduces the lender's total loss to a level where it's more financially savvy for him to write it off, rather than sue the former homeowner [source: Foreclosure.
Many homeowners have spent years building up equity in their homes, only to watch it vanish as a result of the housing crisis. Depending on the circumstances, homeowners who experience foreclosure can expect to wait two to seven years to purchase another home. While a foreclosure essentially lets you walk away from your home—albeit with grave consequences for your financial future, such as having to declare bankruptcy and destroying your credit—completing a short sale is labor-intensive.
However, the payoff for the extra work involved in a short sale may be worth it. Less disruptive alternatives to a short sale include loan modification and utilizing private mortgage insurance. Before resigning yourself to a short sale, talk to your lender about the possibility of a revised payment plan or loan modification. One of these options might allow you to stay in your home and get back on your feet. Another possible option for staying in your home arises if you have private mortgage insurance PMI.
If the PMI company thinks you have a chance at recovering from your current financial situation, it may advance funds to your lender to bring your payments up to date. The source of the financial trouble should be new, such as a health problem, the loss of a job, or a divorce, rather than something that was not disclosed when the homebuyer originally applied for the loan. However, if you feel you were a victim of predatory lending practices, you may be able to talk the lender into a short sale even if you have not had any major financial catastrophes since purchasing the home.
To put yourself in a more convincing position to complete a short sale, stop purchasing non-necessities. Be aware of other circumstances that may prevent the approval of a short sale. If the lender thinks it can get more money from foreclosing on your home than from allowing a short sale, it may not allow one. If someone cosigned the mortgage, the lender may hold that person responsible for payment rather than doing a short sale.
If you think your situation is ripe for a short sale, talk to a decision-maker at the bank about the possibility of engaging in this type of transaction.
At this point, you should consult an attorney, a tax professional, and a real estate agent. While these are high-priced professional services, if you make a mistake by trying to handle a complex short-sale transaction yourself, you may find yourself in even bigger financial trouble.
You may be able to pay for these service fees out of the sale proceeds from your home. Professionals accustomed to dealing with short-sale transactions will be able to give you guidance on how to pay them. When setting an asking price, make sure to factor the cost of selling the property into the total amount of money you need to get out of the situation.
Of course, you want to sell the home for as close to the value of your mortgage as possible, but in a down market, there is bound to be a shortfall. In some states, even after a short sale, the bank will expect you to pay back all or part of that shortfall. These may include bank statements , medical bills, pay stubs, a termination notice from your former job, or a divorce decree.
It is up to you to come up with a proposal. Be aware that the lender ultimately must approve a short sale after receiving all the details because the lender is the recipient of the proceeds. Your job is to find a buyer for your home. Along with the documentation of your distressed financial status, your proposal should include a hardship letter explaining the circumstances that are preventing you from making your mortgage payments.
You want to make it as convincing as possible and protect your interests while also appealing to the bank. Be careful about submitting your financial information to a lender because, if it does not approve the short sale, it may use your financial information to try to get money out of you in foreclosure proceedings. If you still have cash assets , you may be expected to use them to continue making mortgage payments or to make up some of the shortfalls between the sale price and the mortgage amount.
An attorney experienced in completing short sales can help you navigate the details. Because short sales can take longer than regular home sales due to the need for lender approval, they often fall through. The buyer may find another property while waiting for an answer from you. Be prepared for this possibility. If the short-sale transaction goes through, consult with the Internal Revenue Service IRS to see if you will have to pay taxes on the shortfall.
Also, be aware that a short sale can still affect your credit score in the sense that the months of mortgage payments you missed prior to the short sale can show up as delinquent payments on your credit report. Your bank may be more likely to be generous in this regard if you brought up your hardship before you were significantly behind. For credit purposes, while this is somewhat damaging, it is certainly less damaging than a foreclosure.
Short sales can also provide excellent opportunities for buyers to get into houses at a reduced price. Here are a couple of tips to help you make smart decisions when considering the purchase of a short-sale property. Most short-sale properties are listed by real estate agents and on real estate websites. Some listings may not be advertised as short sales, so you might have to look for clues within the listing, such as being subject to bank approval or giving the bank time to respond.
An experienced real estate agent can make a big difference in terms of both finding and closing short-sale properties. Holders of this certification have received specialized training in short sales and foreclosures, qualifying sellers for short sales, negotiating with lenders, and protecting buyers.
Realize in advance that short sales are complicated, time-consuming transactions. It can take weeks or months for a lender to approve a short sale and many buyers who submit an offer end up canceling because the short-sale process takes too long.
Rules for short-sale transactions vary from state to state, but the steps normally include:. If you are buying a house in a short sale with the intention of flipping it, the key to a profitable transaction is a good purchase price.
In real estate investing , it is said that the money is made in the buy. This means that a good purchase price is often the key to a successful deal. If you can get a property for a good price, you increase the odds of coming out ahead when it comes time to sell. You should be able to buy the property, put it in great condition, and sell it at a price where you can still make a profit. Investors need to be able to turn around and sell the house quickly—typically at below-market—and a good purchase price makes this possible.
The purchase price is only one important number, however. Costs to consider include material, labor, permits, inspection fees, trash removal, storage costs, and dumpster rentals. A good inspection before making the purchase can alert you to any large expenses, such as a cracked foundation, faulty wiring, or extensive termite damage. Investors look at this number to determine whether a property has profit potential. These are homes that have recently sold in the area typically up to a mile away from the subject property that have similar features in terms of square footage, such as the number of bedrooms and bathrooms.
Carrying costs are your expenses for holding onto the property. The longer you own the property, the more you will spend on carrying costs, which include:. In order for an investment to be profitable, the sum of your costs the purchase price, repair and renovation costs, and carrying costs must be lower than the ARV.
If your costs are close to or higher than the ARV, it will be difficult or impossible to make a profit. You can determine the potential profit by subtracting the purchase price, repair and renovation costs, and carrying costs from the ARV:. Under these guidelines, total investment purchase price, repair and renovation costs, and carrying costs should not exceed:. The various investment levels are used to reduce risk in changing market conditions.
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