How Does Short Sale vs. Foreclosure Affect Credit Ratings?

Many homeowners we work with have questions about how a short sale may affect their credit score, and how that compares with the implications of allowing your home to go into foreclosure.

The short answer is that both will lower your credit rating, however there are many benefits to choosing a short sale over foreclosure. We've put together more information about how short sales and foreclosures affect FICO scores on our website. It includes two documents that our colleagues at Windermere Mortgage Services created that may be helpful for clients who owe more than their home is worth and are looking at their available options:

The Impact of Short Sale and Foreclosure on Your Credit Score

How Your FICO Score is Calculated

What "Lender Consent" Does (and Does Not) Mean

The term Lender Consent is found throughout Form 22SS, the short sale addendum to the purchase & sale agreement. When we're working with a buyer's agent on a short sale, we often find that there is a lot of confusion about what Lender Consent really means. What is does not mean is that the deal is done. Unlike a standard sale, there are two parts to a short sale closing. Here's how the process works:

Once an offer for a short sale purchase is agreed upon by the bank, they send the seller a written approval letter that outlines the terms under which the lender will authorize the sale. The letter includes the price, deadline for closing date and may address how the debt is treated. It may also include a dollar amount the seller must bring to closing or other terms. For the sale to actually proceed, the seller must agree to all the terms in the lender's approval letter. The seller's other option is to terminate the agreement. The sale will not move forward until the seller gives notice to the buyer that they have received the approval letter and have consented to the terms. We have additional FAQs about the short sales process on our website.

How Brokers Can Avoid Common Short Sale Mistakes

Any broker who has worked on a short sale will tell you that it is much more complicated than a traditional real estate transaction. There are additional forms, endless calls to lenders, and numerous decisions you need to make along the way that can make or break a deal. Here are three of the most common mistakes that I see, and advice on how to avoid them.

Mistake #1: Assuming the bank is working on the transaction.

Just because you've submitted all the right documents to the lender doesn’t mean the process is moving forward on their end. Over the years we've sent countless reams of paperwork to lenders only to find that no one there has any record of receiving them. Regular confirmation and follow-up is critical. Your transaction may be one of thousands that the bank's negotiator is working on at any given time, so it's easy for your documents to get lost in the shuffle. Persistence and patience pay off big dividends in short sales.

Mistake #2: Thinking lender approval of an offer will automatically postpone foreclosure proceedings.

Several of our clients have received a letter of approval from the bank for the sale of their property only to receive a notice of foreclosure from that same lender a few days later. Loss mitigation and foreclosure are handled by separate departments at the bank, and they rarely communicate with each other. You need to be the communication bridge for your client and insure that all parties have the information necessary to postpone foreclosure and move the sale forward.

Mistake #3: Assuming that the short sale approval letter includes satisfaction of the seller's debt.

We always negotiate with lenders for satisfaction of our seller's debt, and have an excellent track record of achieving that goal. The short sale approval letter needs to clearly state that the lender is agreeing to waive all rights to the deficiency. Unfortunately, many approval letters contain ambiguous language. Make sure and clarify any language in the document before your seller signs or they risk having the lender come back at a later date to collect any balances due after the sale. You can find further clarification of the difference between a full debt satisfaction and a lien release in our Short Sale FAQs.

Foreclosure Fairness Act Success Story

The Washington State Foreclosure Fairness Act that went into effect in August requires lenders to discuss potential mediation options with homeowners before initiating foreclosure procedures. And it's working.

We recently listed a home with a seller who was attempting to do a short sale. We got a solid offer from a buyer that met all the bank's criteria and submitted all the paperwork. However, the home was on the verge of foreclosure, with an auction already scheduled. We advocated on the client's behalf with the lender, but were told they would not postpone the auction to consider the offer. We counseled the seller to call the FFA Hotline and outlined all the information they would need to present. Now for the good news: As a result, the auction was postponed and the original offer is currently in the lender's system awaiting approval.

You can access the Foreclosure Fairness Act Hotline at 1-877-894-HOME (4663). Here are details about how the Foreclosure Fairness Act works.

Buyer's Brokers: The most important step in buying a short sale

We get many questions from buyer's brokers about things they can do to make sure their client's short sale offer is approved. The single most important step you can take as a buyer's broker to ensure success in a short sale is this: Qualify the listing broker.

If the listing broker is unfamiliar with short sales, no matter what you do on your end, the chance of a successful outcome decreases dramatically. If your client is interested in a short sale property, call the listing broker and ask them these qualifying questions:

1) Who will be negotiating the short sale?

2) How long have they been negotiating short sales?

3) How many short sales have they closed?

4) Do they have experience with the HAFA process? (HAFA provides incentives for the seller such as a $3,000 relocation incentive, and an agreement by the lenders to forgive the debt, which increase the likelihood of seller participation in the short sale.)

5) What is their system for communicating with you, the buyer's agent, so you know how the transaction is progressing?

Asking these questions will help you determine whether the broker has the level of experience needed to successfully negotiate a short sale-- and it can save you and your client a lot of time and frustration.

Is Buying a Short Sale Right For Your Client?

With short sales making up a significant part of inventory today, your buyers will no doubt run across short sale homes that they're interested in. There are bargains to be had, however short sales do differ in a number of ways from conventional home sales. Here are a few things to let your clients know if they're thinking about buying a short sale property.

Short sale homes sell for less, but not significantly less than market value.
Buyers hoping to snap up a home for half the market value will be disappointed. The selling price for short sales average about 10 percent less than for non-distressed properties. The bank is looking to recover as much of the value of the home as possible, so they will not accept offers that are significantly under market value. That said, with savings that can equal tens of thousands of dollars, a short sale is a great way for a buyer to get more house for their money.

Short sale properties are sold "as is".
The lender will not be making repairs to the home. Any improvements that need to be made are most likely going to be the responsibility of the buyer. It's a smart move for you to get contractor bids for any necessary repairs and use those to help negotiate a lower sales price.

A short sale will take longer than a conventional home sale.
Once your client and the seller have mutual acceptance on an offer, you need to allow 60 to 90 days for the lender approval process. There are often long stretches when the offer is slowly winding its way through the bank's system, so buyers need to be patient.

If your buyer has to sell you’re their home first, a short sale is probably not the best fit.
Lenders generally will not take contingent offers on a short sale.

The bottom line: As long as your buyer can be patient, and you're working with a listing broker who understands the process, buying a short sale is a great way for your client to purchase the house they want at a great price.

How to Use the New Short Sale Form 22SS to Your Advantage

This fall the Northwest Multiple Listing service made revisions to Form 22SS, the Short Sale Addendum to the Purchase & Sale Agreement- and we continue to get lots of questions about what that means to brokers.

One key change is that the new form presumes that the seller has the right to consider other offers after mutual acceptance (Paragraph #3). Another change is the option to have timelines in the agreement begin on mutual acceptance rather than the notice of lender consent (Paragraph #5).

Ultimately, the changes allow the listing broker more flexibility in negotiating the short sale based on the property and the situation. However, by opening up a greater number of options, it has also made this short sale form a bit more complicated.

Since every transaction is unique, there are no universal guidelines for which boxes to check or how you may want to alter the language of the addendum. The factors that will help you decide which course of action is in the best interest of your seller include:
The profile of the buyer
How committed the buyer is to the transaction
Who the lenders are
The price point of the property

Here's an example: You have what you've qualified as a strong offer. The buyer would like to close the sale as quickly as possible. You negotiate an agreement to deposit earnest money and do an inspection on mutual acceptance, rather than lender consent. The buyer's willingness to make a financial investment let's you know that they're really interested in the house. If they hesitate, you may have a less committed buyer.

Second, an inspection at mutual acceptance will help everyone in the transaction get their needs met. Most short sale sellers don't have the money to pay for the repairs that may be outlined in the inspection report. And the bank has set an "as is" value for the house. You're familiar with this particular lender's short sale process, so you know that if you submit a lower offer with an inspection report and contractor bid attached that explains the difference, your chances of getting a price reduction accepted by them is much greater. If you wait until lender consent to do the inspection and subsequently lower the offer price the chance that the bank will change its mind are very low.

10 Key Questions To Ask Short Sale Clients

When we get an initial call from a homeowner, they usually don't know if they need a short sale or not. In fact, they don't commonly know what a short sale is. To help determine where they are and what options are available to them we ask a standard set of questions. These key questions can help you discover how difficult the transaction will be, set proper expectations for the seller and position yourself as someone who can successfully solve their problem.

1) How many mortgages do you have and how much do you owe on each?

Since homeowners often don't know if they need a short sale or not, your first task is to determine the total amount of mortgage debt they have.

2) If you were to put your home on the market today, what do you think the price would be?

If the value the homeowner estimates for the home is less than what they owe, you know they're underwater. Keep in mind that most homeowners tend to overestimate the value of their home, but their opinion will give you a point to start your assessment.

In addition, the homeowner's estimate of the home's value is a valuable piece of information in managing their expectations and tempering your discussions. If a homeowner has a highly inflated view of the what their home is worth, you'll need to take some time to help them understand its current market value.

3) Are you current or behind on your payments?

If they're current, qualifying for a short sale is more difficult, though there are circumstances where it's possible. If they're behind, you can start to evaluate whether they will meet the criteria for financial hardship that lenders require for short sales.

4) Who are your mortgages with?

Because each lender has their own short sale process, knowing who the lenders are will help you determine potential recourse and timelines for approval. Knowing upfront how long the approval process takes will drive your marketing. For example, if Bank X is the lender and they take an average of 90 days for approval, you're looking at a five month process for closing. That timeline helps you define the type of buyer you need to find. If a buyer needs to move into a new home within 60 days, no matter how much they like the house, they're the wrong fit.

5) Have you received any notices from your lender?

This will help you determine the potential for foreclosure and the timeframe available to you to attempt a short sale. A Notice of Default is a private notification from the bank to the homeowner. It's the start of the foreclosure process. Generally, once your client has received a Notice of Default, you have less than four months to come to an agreement with the lender on a short sale. A Notice of Trustee Sale is a public notification from the lender indicating when the home will be put up for auction. If your client has already received a Notice of Trustee Sale, your timeline for finding a buyer and selling the home is significantly shortened.

6) Who is on the title?

It's surprising how many times homeowners aren't aware of who is on the title. A common scenario is a title that lists an ex-spouse, in which case that individual will need to be involved in the process as well. Pull the paperwork so you know who is legally obligated in the transaction.

7) Has the home been listed recently?

If it has, that listing price will help you determine what the market has established as its value.

8) How many beds and baths are there?

You want to gather information so you can accurately assess the value of the home. It's not unusual for a 2 bedroom/1 bath home to show up in the county records as having 2 bedroom/1 1/2 baths. This is also the time to ask about other qualities of the home that may negatively affect the value, such as a less than desirable location next to a freeway or a basement that floods regularly. When we work with brokers on negotiating a short sale, one of the critical steps is gathering information beyond the square footage and bed and bath count the lender will be relying on to value the property.

9) Does the home need any structural repairs?

If the home needs a new roof, you'll want to get bids that you can submit to the bank to help them set an appropriate price for the property that the market supports.

10) What's the best way for me to contact you?

Some clients prefer phone calls; others text or email. Calls during work hours are fine for some people and not for others. By respecting their preferences, you let your client know that communication is a priority for you. (Note: Lack of communication is one of the top complaints sellers have about the short sale process.)