Recently in an office discussion we were talking about how foreclosures, bankruptcies, and short sales could affect a person's credit ratings. The interesting thing is that a group of professionals could not come up with a solid answer so I thought I would dig in a little deeper and see if I could help all of us.
First things first, all of the above mentioned items will hurt your credit score. There is no way around it. If a house goes into any sort of default there will be repercussions. The debate is on what can a person do to minimize that damage. A side issue is how long will a person be damaged by one of those events.
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Let me be clear before I try to answer those questions. There is no hard set rules to follow. There are some facts we do know and some we do not know. Every situation is unique so for your particular case check in with a lawyer or CPA as your situation dictates. This is not legal advice - I am just trying to make a little sense out of a very complex situation.
Bankruptcy Chapter 7/11 (complete dismissal):
FICO effected for 10 years To obtain credit to purchase a home 4 years; 2 years with extenuating circumstance
Bankruptcy Chapter 13 (reorganization):
FICO effected for 7 years To obtain credit to purchase a home 2 years from discharge or 4 years from dismissal
Foreclosure
FICO damage varies depending on how long and how many accounts go into delinquency To obtain credit to purchase a home after 5 years; 5-7 years you will need 10% down with a FICO of 680 or higher. If you have IRS defined extenuating circumstances the wait period can be as low as 2 years with 10% down or lender requirements
Short Sale - Non default (you never missed payments)
FICO likely unaffected or slight drop Can obtain credit to purchase a home immediately as long as no accounts are 30, 60, 90, or 120 days delinquent and there is no promissory note to pay a lender as a result of the short sale
Short Sale - With default/delinquency
FICO damage varies depending on how long and how many accounts go into delinquency Can obtain credit to purchase a home in 2 years
There are 3 Key lessons I want to highlight. First is the question will a short sale be better on my FICO then a foreclosure? This is a tough one to answer. According to myfico.com the effects of a short sale and foreclosure are equal. Both are recorded the same in your credit files. But I have heard personal anecdotal accounts where short sales affected a persons credit score by 100 points less than a foreclosure. After scouring the web I have come to a PERSONAL BELIEF for these conflicting reports. It all depends in how many and how long defaults a person has.
Let me give you an example:
Person A has 3 credit cards and a home loan. The home loan goes into default for a total of 60 days past due but all the credit cards are paid on time Person B has 3 credit cards and a home loan. All 4 accounts go at least 60 days past due.
Let's say Person A has a foreclosure while Person B goes with a short sale. It is my belief because there were multiple accounts in default for person B, even though he does a short sale, his FICO will be hurt more because of the volume of defaults - not the type of sale.
The lesson here is if you want to protect your FICO as much as you can then have as little defaults as possible and for as short of a time period behind as possible. If you see trouble brewing act now!
The second key lesson, and a variation of this one, is the short sale with no defaults or late payments. This is the only station out of all of them where you can come up basically unscathed. The key lesson here is if you can reasonably foresee a default situation in your future then jump on a short sale now. You do not have to be in default in order to short sale. Lenders and the government have loosened short sale situations to include people with documented hardship that will likely cause a default in the near future. One key element in this situation is to have no promissory note as a result of the short sale. This is where a real estate agent with advanced training like a CDRS certification can help you.
And finally, if you are in default a short sale is better than a foreclosure because you will be able to qualify for a new loan greater than twice as fast.
At the time of writing these figures are not guaranteed but believed to be accurate. Consult a lawyer, certified public accountant, or real estate professional to discuss your situation. Information comes from http://www.car.org and http://www.myfico.com
I hope you found this information useful. I discuss many different real estate issues on my site. A link is provided below. If I can answer any questions for you, no matter where you live, please feel free to drop me an e-mail.
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