The following is my response to an e-mail I recieved from a nice couple in Illinois. Their current home had lost about 50% of it’s value and they needed to move because of an expanding family and proximity to their work. Because they owe about $80,000 more than their house is currently worth, they needed advice on what their options were. Here was my reply that I thought might be helpful to others in a similar situation.
So, my first question would be…whats the rental market like near you? If you think you can rent out your current house to cover the payments and other expenses (taxes, insurance, hoa dues, etc.) that could save you some financial pain, although it would mean becoming a landlord which can be a hassle of you dont have the right tenants. If you were able to get a signed lease, the bank may include that as additional income to get you qualified for a loan to buy the new house. (Check with your lender to verify this…they all have their own way of doing things.) This method would prevent any credit score damage and foreclosure issues and still get you into your new place. In addition, You may be able to hold on to the house until the market improves and sell it then. Do some number crunching and look in the paper for rental rates in your area for a similar house. If there is any way that you can afford to do this, I think it is the best option.
If you decide you do not want to go the landlord route, or if you cant get a new loan without selling the old house, then a short sale is definitely better than a foreclosure, although it will still hurt your credit a bit. A foreclosure is nasty, and makes it nearly impossible to get a mortgage for 5-7 years, as well as doing a number on your credit score. Then if the lender cant sell the house for as much as the amount that was owed, they could come after you for the difference! I would definitely avoid this choice if at all possible.
A short sale on the other hand, although it does affect your credit score, does not have all of the negative repercussions that a foreclosure would. (Many experts are not sure how much short sales will affect scores, because they are just now becoming popular due to the economic situation we are all facing now. Ive seen estimates from as little as 50 points to up to 200 points. Either way, your score can be brought up again relatively quickly if you stay on top of all of your other payments.) Most lenders will report the short sale as settled for less than the amount owed in your credit report. The big question is how will lenders look at this in the future. My guess is that because there are so many short sales now, if mortgage companies want to do much business in the future, they are going to have to be pretty lenient when it comes to folks that have a short sale in their report.
The FHA or Federal Housing Authority, who is a governmental agency that insures many of the loans made to people buying their primary residence (No investment properties or vacation homes), requires a waiting period of two years after a short sale to get approved for one of their loans. Most of the major lenders have guidelines that are close to this. (Wells Fargo says 3 years for example.) That being said, if you need to move now, it might be a good idea to get the new loan and complete the purchase of the new house before the short sale shows up on your credit report. The problem here is that you can get stuck with two mortgage payments for the time it takes to get the old house sold unless you do things in the right order.
So this is where a good realtor and mortgage person come in. Things have to happen in a very particular order for this to work out. This is what I would recommend:
1. Talk to a Realtor who has the SFR designation and one that you trust to handle this. (I can help you find someone qualified in your area if you would like.) Get your old house listed for sale at a price that the realtor thinks will get it sold in 30 to 60 days. Also have the realtor start the short sale process by sending in any financial info, the listing agreement and short sale application to your lender.
2. Apply for a new loan and let the lender know that you will be selling your current house.
3. Start looking for a new house
4. Get an offer on your house AND get the bank to approve the short sale. Make SURE that you have something in writing from the lender that states that they will not pursue a deficiency judgment. Meaning that they will not come after you for the difference between the sale price and the amount owed. This is the most important part of the short sale. Sometimes they will ask you to sign a promissory note to pay off the difference. Remember that these are negotiations and that the lender is simply trying to minimize their loss.
5. Put in an offer that works for you but make sure that the offer is CONTIGENT ON THE SUCCESSFUL CLOSING OF YOUR CURRENT RESIDENCE. Some sellers will not like this but many are taking whatever they can get in this market. Schedule the closing on the new house to be within a week of the closing on your old house. This way the short sale will not be on your credit report until after the new loan is already closed. Even better if you can have both closing on the same day.
6. Confused yet?
As far as getting approved for a short sale, banks are typically looking at these things:
1. Is the house your primary residence? They have programs and incentives such as HAFA that makes it easier to get approved when it IS your primary residence.
2. Do you have a legitimate financial hardship? In your case, if your income has not gone down, your argument is that you HAVE to move for your job and that you cannot afford two mortgage payments and cant get the old house rented for enough to cover the payments. If they think that you can afford your current house and that relocation isnt absolutely necessary, they will probably not approve the short sale.
3. Will the house go to foreclosure if they do not approve the short sale? For this they look at your financial information and your work situation to try to determine whether or not they think you could afford to keep making the payments.
4. Will the short sale cost the lender less than a foreclosure would? This one is really out of your hands, but typically the answer is yes because of the long, expensive process of doing a foreclosure.
Another good option if you can’t get a loan to purchase a home is to consider renting for a short time. You could get into a house that suits your needs, in a location that you want, and still have the option of leasing or doing a short sale on your current home.
Hope this is helpful and doesnt confuse you more! Feel free to call me with other questions or if you want me to recomend a qualified realtor in your area.
-Mike
