11/20/2009

How Does Bankruptcy, Foreclosure or a Short Sale Affect the Borrower?



The FICO® score was established by the Fair Isaac Corporation and is one of several systems which evaluate a borrower's credit worthiness by assigning a numeric value. A score of over 720-740 points is considered the desired range of eligibility for a conventional loan by many lenders. Before the current economic downturn, a score of 680 was acceptable and eligible for many conventional loan programs, but that score now does not meet many, if not most, current guidelines. The borrower should take into consideration that FICO® or other credit scores are now checked when applying for home insurance, rentals, a car loan, and employment, to name a few, an individual's credit worthiness is an important fact of life. When a borrower is considering the best course of action, they often do not realize exactly for how long and in what ways a distressed property situation will affect them.



The pie-chart shows the parts of a FICO® score found at www.myfico.com and the aspects of a credit score. While there are general estimates as to the "hits" to your score for bankruptcy, foreclosure, short sales, and late payments associated with these events, opinions differ and are not exact, in spite of what information you may find on various internet sites. Other factors in the borrower's credit history may also impact the total score.

However, certain Fannie Mae borrowing guidelines are known:
  • A 10% down payment purchase of a principal residence is allowed 5-7 years after a foreclosure sale completion date (3 years for "extenuating circumstances").
  • A 10% down payment purchase is allowed for a principal residence and other types of properties 4-7 years after a deed-in-lieu was executed.
  • 2 years after a "pre-foreclosure" sale (may or may not be same as short sale conditions).
  • 4 years after a bankruptcy discharged or dismissed.
  • 2 years after a Chapter 13 bankruptcy is discharged or dismissed.
FHA may have slightly more lenient guidelines for post-event home purchases, and the borrower should check with a lender. The idea here is not to give a complete listing of guidelines--a discussion with an experienced lender would be good for that--but to let the borrower know what the timeline will be depending on his/her actions and plan accordingly. The potential tax consequences depending on circumstances of the property should be reviewed before filing for bankruptcy, for example.

The choices in some cases are not avoidable, but in all cases, a borrower should obtain more information to be prepared.

2 comments:

Rob Viglione said...

It is important to keep credit scores in perspective with life, and economic opportunities.

The fundamental reality is that a bad FICO reduces access to credit markets. The decision to default on debt should consider:

1) Do you need (or want) continued access to credit markets? In many cases being cut off from more credit could be a good thing!

2) Do you have special circumstances that require strong credit? Corporate executives, federal employees with security clearances, and other select groups could lose privileges or access to key positions in the advent of default.

If you do not need, or want, access to credit for a period of time, and you do not fall into the special circumstance category, you may want to seriously consider bankruptcy or foreclosure immediately. The longer you wait the more desperate your situation will become. Halting payments and initiating default is the first step in repairing your savings account; which, to me, is far more important than repairing access to credit.

One note on short sales and foreclosures is that lenders often have the right to seek deficiency judgments in court to recoup losses. Each state has its own laws for deficiency judgments, so do your research. Here's a link explaining that it's mainly second mortgages and hard money loans that are susceptible to deficiency judgments:

http://tinyurl.com/ybxlpyf

Julia Huntsman said...

Anyone contemplating bankruptcy or foreclosure should ALWAYS contact a tax or legal advisor first. Even bankruptcy may not always protect against the consumer against the lender's recourse or IRS payments, especially in those situations where a second loan or a refinanced loan is involved. And if and when a seller obtains a short sale approved by the lender, it's best to have that approval also reviewed by a trusted legal or tax advisor who is knowledgeable in that area of bankruptcy, foreclosures and the effects of distressed sales.

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