Short sales routinely show up in credit reports as foreclosures
Large numbers of homeowners who have negotiated short sales are at risk because of a startling omission in the credit system. Their credit reports and scores indicate that they were foreclosed upon, rather than having negotiated a mutually agreeable resolution with their lender, and the Federal Trade Commission and the Consumer Financial Protection Bureau are investigating why and how this happened.
Making sense of the story
- The credit reporting system now in place does not have a separate code that distinguishes a short sale from a foreclosure, yet there are crucial differences between the two.
- In a short sale, the bank approves the sale of the house to a new buyer at a mutually acceptable price. Any unpaid remaining loan balance not covered by the sale proceeds may then be either partially or fully forgiven. The bank is an active participant throughout the process, negotiating for a higher price and higher repayment of principal from the original borrower.
- In a foreclosure, the bank is essentially left holding the bag. The owners walk away at some point or live in the property rent-free until they’re evicted. Frequently there is damage to the house left by the departing owners, sometimes extensive. There is little or no cooperation between the homeowners and the bank.
- Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) all recognize the differences between short sales and foreclosures in their underwriting policies regarding new mortgages.
- Fannie Mae generally won’t approve a new mortgage application by borrowers with a foreclosure on their credit report for up to seven years, but will consider lending to people who were involved in short sales, and who otherwise qualify in terms of recent credit behavior and available down payment, in as little as two years.
- If short sales routinely show up in credit reports coded as foreclosures, borrowers who might be able to qualify for a new mortgage two or three years after a short sale may find themselves shut out of the market
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