Can't Afford It! Can't Sell It! Can't Refinance It!

Can't Afford It! Can't Sell It! Can't Refinance It!
Answers to Those Tough Questions About Credit in Today's Environment

Brought to you by John Nunnally

When a homeowner finds themselves upside down in their mortgage payments, they have no idea of which direction to turn, and It seems that it is almost impossible to get straight answers to their questions about what options they have, and how each option will affect their credit.

Many families know, with certainty, they will have to leave their homes. Their biggest question now is how to most effectively do so without devastating their credit scores so they will someday be able to buy a home again.

Now is the time for tough questions to be asked and answered. Here is a breakdown of homeowner options, and how each affects the credit scores:

FORECLOSURE

Foreclosure is the legal process in which a bank or other secured creditor either sells or repossesses a parcel of real property, home or land, after the owner has failed to comply with the mortgage or deed of trust agreement with the lender. Most frequently, the violation of the mortgage agreement is the default of payment. The completion of the foreclosure process allows the lender to sell the property, and keep the proceeds to pay off the mortgage as well as any legal costs. The length of the foreclosure process varies from state to state.

If the foreclosed property is sold for less than the remaining primary mortgage balance, and there is no insurance to cover the loss, the court overseeing the foreclosure process may enter a deficiency judgment against the borrower. Deficiency judgments can be used to place a lien on the borrower's other personal property, obligating the borrower to repay the difference or suffer the loss of their property. It gives the lender a legal right to collect the remainder of debt out of borrower's other existing assets.

However, there are exceptions to this rule. If the mortgage is classified as "non-recourse debt," then the borrower has no personal liability in the event of foreclosure. This is often the case with residential mortgages. If so, the lender may not go after borrower's personal assets to recoup additional loss.

The lender's ability to pursue a deficiency judgment can be restricted by state laws. In California and some other states, original mortgages (the ones taken out at the time of purchase) are typically non-recourse loans, however, refinanced loans and home equity lines of credit aren't.

If the lender chooses not to pursue deficiency judgment-or can't because the mortgage is non-recourse-and writes off the loss, the borrower may have to pay income taxes on the un-repaid amount if it can be considered "forgiven debt."

Any other loans taken out against the property being foreclosed (second mortgages, home equities) are "wiped out" by foreclosure (in the sense that they are no longer attached to the property), but the borrower is still obligated to pay them off if they are not paid out of the foreclosure auction's proceeds.

How Does a Foreclosure Affect Credit?

A foreclosure can be reported as a Foreclosure or Repossession and carries the most negative penalty on a credit score just under a public record (i.e. Bankruptcy, Tax Lien or Judgment.) There is a misconception that foreclosures are considered public records to the scoring system, however, they are not. Although there is a Public Notice Record on file once a foreclosure is started, this record is completely different than a credit report public record.

A Foreclosure will remain on a credit report for 7 years from completion date. And the credit score will drop from 50-250 points. The difference in point loss depends on how many points someone has to lose in the payment history factor of their credit report. So if someone has a 750 credit score, and they opt to foreclose, their score could drop up to 250 points. However, if someone has a 500 credit score, they may only lose 50 points for the same derogatory.

If a Deficiency Judgment or Tax Lien is filed in connection with a Foreclosure, the credit score can drop an additional 100 points.

How Long Before You Can Buy Another Home After Foreclosure

There are several loan products available, and I would be happy to tell you what your options are when it comes to home loans, however, for the purpose of this newsletter I am going to use the guidelines of Fannie Mae & Freddie Mac, two companies that own or guarantee about half of the U.S.'s $12 trillion mortgage market.

The current guidelines from Fannie Mae & Freddie Mac state the waiting period for a foreclosure is 5 years from the date the foreclosure proceeding is completed.

However, if there are extenuating circumstances that caused the borrower to have to enter into a foreclosure proceeding, such as loss of employment or a severe medical crisis, if approved, the waiting period is 2 years from the date the foreclosure proceeding is completed.

In General: When it comes to foreclosure and how it affects the ability to obtain credit in the future, there are multiple points of extremely negative impact. Deficiency judgments for the amount not collected by the lender in the foreclosure sale can end up on a borrower's credit report as a derogatory mark. Additionally, there is a high risk that the borrower will be hit with a substantial tax penalty which can result in a tax lien, which also appears on the credit report. As a general rule, other than a bankruptcy, foreclosure is the least desirable of all of the options available when a borrower is upside down in a home mortgage.

Deed in Lieu Of Foreclosure

An alternative to foreclosure is a "deed in lieu of foreclosure." In this scenario, the borrower turns the house over to the lender and walks away without owing anything. A deed in lieu of foreclosure offers several advantages to both the borrower and the lender. The main advantage to the borrower is that it immediately releases him or her from most or all of the personal debt associated with the defaulted loan. The borrower also avoids a foreclosure proceeding and may receive more generous terms than he or she would in a formal foreclosure. Advantages to a lender include a reduction in the time and cost of repossessing the property.

In most instances, in order to be considered for a deed in lieu of foreclosure, the total debt on the property should be secured by the real estate being transferred. Both sides must enter into the transaction voluntarily and in good faith. The settlement offer must at least be equal to the fair market value of the property being turned over. Generally, the lender will not proceed with a deed in lieu of foreclosure if the outstanding debt on the property exceeds the current fair market value of the property, and in today's market this is most likely not the case.

Because the agreement must be voluntary, lenders will often not act upon a deed in lieu of foreclosure unless they receive a written offer from the borrower that specifically states that the offer to enter into negotiations is being made voluntarily. This will enact the parol evidence rule and protect the lender from a possible subsequent claim that the lender acted in bad faith or pressured the borrower into the settlement. Both sides may then proceed with settlement negotiations.

Neither the borrower nor the lender is obliged to proceed with the deed in lieu of foreclosure until a final agreement is reached.

How Does a Deed in Lieu Of Foreclosure Affect Credit?

Most lenders report a deed in lieu of foreclosure as a foreclosure, so the credit scores will carry the same serious affect as if it were an actual foreclosure. However, what most borrowers don't know is that they can negotiate with the lender to report it differently in return for turning over the deed and avoiding foreclosure costs.

Many lenders will say that they cannot change the reporting status, but they can. Here are the credit reporting options in preferred order:

• Paid As Agreed - Credit scores will have already dropped over 100 points due to default in payments, however, if reported as Paid As Agreed, the borrower will be able to purchase another home in a shorter time period.
• Paid Settlement - Credit scores could drop up to 150 points.

The item will remain on the credit report for 7 years from the completion date or the settlement date.

How Long Before You Can Buy Another Home After Deed In Lieu of Foreclosure?

The current guidelines from Fannie Mae & Freddie Mac state the waiting period for a Deed in Lieu of Foreclosure is 4 years from the date the proceeding is completed.

If there are extenuating circumstances that caused the borrower to have to enter into a Deed In Lieu of Foreclosure proceeding, such as loss of employment or a severe medical crisis, if approved, the waiting period is 2 years from the date the proceeding is completed.

Short Sale (aka Pre-Foreclosure Sale)

The best option is a short sale, which occurs when a bank or mortgage lender agrees to discount a loan balance, due to an economic hardship on the part of the home owner. The home owner sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender in full satisfaction of the debt. In such instances, the lender would have the right to approve or disapprove a proposed sale.

A short sale is typically executed to prevent a home foreclosure. Lenders often choose to allow a short sale if they believe that it will result in a smaller financial loss than foreclosing. For the home owners, the advantages include avoidance of having foreclosures on their credit histories. Additionally, a short sale is typically faster and less expensive than a foreclosure.

Junior lien holders, such as holders of second mortgages, HELOC lenders, and homeowner associations (special assessment liens), may also need to approve the short sale. Frequent objectors to short sales include those who hold tax liens (income, estate or corporate franchise tax - as opposed to real property taxes, which have priority even unrecorded) and mechanic's lien holders. It is possible for junior lien holders to prevent the short sale.

While it is frequently common for a lender to forgive the balance of the loan in question, it is unlikely that a lien holder that is not a mortgagee will forgive any of their balance. Further, it is common for a lender to omit updating the zero balance and settlement option on the mortgagor's credit report, or even flat-out refuse to do so "due to their financial loss."

The Mortgage Forgiveness Debt Relief Act Of 2007

When the lender decides to forgive all or a portion of the debt and accept less, the forgiven amount is considered as income for the borrower, like with a foreclosure, leaving it open to be taxed. However, The Mortgage Forgiveness Debt Relief Act of 2007 contains amendments to remove such tax liability, allowing the borrower and lender to work together to find a solution beneficial to both parties.

How Does a Short Sale Affect Credit?

In the wake of the current mortgage crisis, short sales are becoming extremely common, but legislation has not caught up with the tidal wave and there is no law on the books relating to them to date. As a result, there is an opportunity for the borrower to negotiate credit reporting with the lender.

A short sale proves that the borrower is exhausting every effort to pay the loan. The borrower has willingly committed to taking on months of emotional and physical stress in a good-faith effort to sell the property to maintain a good relationship with that lender. Most likely, the reason they can't afford their current mortgage is because they were in an adjustable product and their mortgage payment has doubled. That doesn't mean that they can't afford a different loan program with a lower payment. Which leads me to wonder what the incentive is for lenders not to negotiate with the borrower on how the item is reported to the bureaus. All they would be doing is cutting off a pretty substantial future income stream if they put these types of borrowers out of the market for two years. In that light, negotiation for a non-report on short sales is well worth it.

Here are the credit reporting options in preferred order:

• Paid As Agreed - Won't hurt the score at all as long as the borrower has kept payments current.
  Unrated - May drop a few points.
• Paid Settlement - Credit score will drop 50-150 points.

If reported, the item will remain on the credit report for 7 years from the completion date or the settlement date.

How Long Before You Can Buy Another Home After Short Sale?

A few weeks ago, Fannie Mae & Freddie Mac were going to consider a short sale the same as a foreclosure, however, the current guidelines state the waiting period for a Short Sale is 2 years from the date the proceeding is completed.

There is no exception for extenuating circumstances.

Bankruptcy Mortgage Relief

Currently, bankruptcy offers very limited protection to a homeowner who is upside down with their payments. The borrower can file a Chapter 7 which, depending on the state bankruptcy law, will most likely require him or her to surrender the property to the bankruptcy court, or file a Chapter 13 debt repayment plan to spread out prior delinquent payments over a number of months or years in the future. However, no bankruptcy proceeding can modify the terms of an existing home loan on a principal residence. Legislation is being proposed to Congress that would allow bankruptcy judges to modify the terms of an existing mortgage loan. I would not hold my breath. It could take years to make further substantial changes to the bankruptcy laws.

How Does a Bankruptcy Affect Credit?

My advice is to avoid Bankruptcy at all costs unless you are upside down on everything. Not only have the new bankruptcy filing requirements become more difficult and more costly, a public record will wreak havoc on credit scores and could stop consumers from being hired or renting a place to live.

A Chapter 7 Bankruptcy will remain on the report for 10 years, and a Chapter 13 will remain for 7. The point loss could be from 100-350 points, depending on how many points you have to lose in this factor.

How Long Before You Can Buy Another Home After Bankruptcy?

The current guidelines from Fannie Mae & Freddie Mac state the waiting period for a Chapter 7 Bankruptcy is 4 years from either the dismissal or discharge date.

The exception for extenuating circumstances is 2 years.

The current guidelines from Fannie Mae & Freddie Mac state the waiting period for a Chapter 13 Bankruptcy is 2 years from either the dismissal or discharge date.

In the case of multiple bankruptcies, the current guidelines state the waiting period is 5 years from the most recent discharge or dismissal date.

The exception for extenuating circumstances in the case of multiple bankruptcies is a 3 year waiting period from the most recent discharge or dismissal date.

WORD OF CAUTION REGARDING EXTENUATING CIRCUMSTANCE: If you have are facing a foreclosure, short sale or bankruptcy due to circumstances of losing a job, a medical crisis, sub-prime mortgage crisis fall-out, I suggest that you fully document your experience starting now. It's not recommended to wait until later, because the details and emotional energy of what you are going through will be more difficult to document and prove down the road if you decide to apply for a loan in 2 years based on an extenuating circumstance claim.

There Is Good News!

• Aging Out: In all instances above where I reference how many points will be lost in each scenario, it is important to understand that over time, all derogatory accounts age out. This means, the older the account becomes, the less it will hurt their credit scores.

• 7 Year Reporting Period: The law states that derogatory items "can be" reported for 7-10 years as outlined above. It doesn't state that they "MUST BE.' My experience proves over and over again that there is no need to wait out the 7 years. You don't have to. You can start seeking early removal of the item by disputing to the credit bureaus that are reporting it. In many instances, after 3-4 years, the item will be deleted.

• You can Start Recovering and Rebuilding immediately. I have the tools to help. If you find yourself, or anyone close to you in a position of having to rebuild and recover, call me, and I will send you some great tips on how you can start improving your credit immediately after crisis.

Final Thought

Foreclosure, Deed in Lieu of Foreclosure, Short Sale, and Bankruptcy can have long-lasting affects on an individual's taxes and ability to obtain credit. Homeowners need to get the facts before making critical decisions that will impact their lives for many years to come. I am here to help should you have any questions that I have not answered in this newsletter. My commitment is to help you become more educated about how the credit scoring process.

All the best,

John