Impacts of a Foreclosure Deed in Lieu Vs. a Short Sale

Short sales and deeds-in-lieu are foreclosure alternatives.

The housing crisis and recession that began in 2007 have popularized the terms deed-in-lieu of foreclosure and short sale. Foreclosure prevention efforts and short sale numbers continue to rise in 2011 as a result of economic conditions, according to the National Association of Realtors. Both the short sale and deed-in-lieu are alternatives to foreclosure that carry credit consequences.

The Basics

Short sales involve selling a home for less than the mortgage amount owed. The transaction requires lender acceptance of the sale terms. Foreclosure is the legal process by which a lender or debt collector deprives a debtor from their ownership interest in real estate. A lender may offer a delinquent borrower the opportunity to voluntarily convey their ownership interest with a deed-in-lieu to avoid the high legal costs of foreclosing. Lenders may make exceptions for borrowers with these credit mishaps if they can document they resulted from unavoidable, extenuating circumstances.

Credit Reporting

According to Fair Isaac, the company that developed FICO scoring, short sales, foreclosure and deeds-in-lieu impact credit scores by an average of 85 to 160 points. The exact amount depends on the borrower's credit strength prior to the event being reported to bureaus; those with high scores have more to lose than those with bad credit. The events are reported as having paid less on a settled account, according to Maxine Sweet, a representative for Experian. As a result, the three credit bureaus generally slash credit scores equally for handling default in these manners.

Future Borrowing

Mortgage lenders approach with caution borrowers who have past short sales or deeds-in-lieu of foreclosure. The uniform residential mortgage loan application used by all lenders specifically ask applicants to declare if they have experienced a deed-in-lieu of foreclosure anytime in the past. Fannie Mae and Freddie Mac lenders require at least two year's seasoning for short sales and four to seven years seasoning after a deed-in-lieu. The Federal Housing Administration, which insures mortgages for credit-challenged borrowers, requires three years for both short sales and deeds-in-lieu.

Considerations

A short sale and a deed-in-lieu damage credit, as both events involve delinquency on a mortgage. Typically, the less time that passes with missed mortgage payments, the less harmful the account is on credit. When foreclosure is imminent, the sooner a borrower short sells or deeds the property back to the lender, the better. They can move on and begin repairing their credit, as the impact on credit lessens with time.

Short sales and deeds-in-lieu on second homes or investment properties, as well as those involving subordinate liens or non purchase-money loan, may result in deficiency judgements. A lender may pursue a borrower after the event, depending on the recourse laws in their state.

References

• My FICO: Credit Q&A: Are the Alternatives to Foreclosure Any Better As Far As My FICO Score Is Concerned?
• CNN Money; How Foreclosure Impacts Your Credit Score; Les Christie; April 2010
• My FICO: How Long Will A Foreclosure Affect My Score?
• My FICO: FICO Forums: Deed-in-Lieu on a Performing Loan
• Fannie Mae: Uniform Residential Loan Application (Form 1003)
• FHA Outreach: Previous Mortgage Foreclosure
• FHA Outreach: Short Sales
• Fannie Mae; Announcement 08-16; June 2008