What is the cost of a foreclosure?
I get a lot of questions posed to me about short sale and foreclosures. An interesting one was posed to me recently. “How much will a foreclosure cost me?”
I had to really think about this question. Sure the standard answer about the difference in being able to obtain a loan in the future with Fannie Mae being 2 years vs. 5 years and the FICO score dropping by up to 250 points came to mind. However, I was thinking that question was asking for a quantifiable number. How could I quantify the cost of a foreclosure?
I spoke with my loan broker and decided to see what the actual cost would be by comparing someone obtaining a loan pre-foreclosure and then post-foreclosure.
Let us assume an individual has a FICO score of 750 and wants to buy a home for $500,000 with 20% down; so he would be borrowing $400,000. By running the FICO score through the Fannie Mae guidelines, this individual can obtain a 30 year fixed loan at 4.735 % and have a monthly mortgage payment of $1,997 as of 7/15/2010.
Let’s assume that same individual had gone trough a foreclosure and had taken a 250 point hit on his FICO score. What would the “cost difference” be for him if he wanted to obtain a loan to buy a house today?
First, any individual with less than a FICO score of 620 cannot qualify to borrow from traditional lenders; the only option available to such a person would be the hard money arena or private lenders.
Private lenders require down payments of 20% , but more like 30-40% . They are also short term loans, so you would only be able to borrow for 5 years or less, you would have to make other arrangements after that point or build up your FICO to the point where you would be able to qualify for a traditional loan. But for easy comparison’s sake, we will ignore those two important facts, since there is no other alternative funding method. Let’s assume an individual is able to qualify for a loan of $400,000 after a foreclosure.
After checking with one of her private money lenders, my loan broker came back and told me a private money lender would charge 10% to lend $400,000. The monthly payment on that loan would be $3,510!
How much will a foreclosure cost? About $1,510 per month, by my calculations.
Please don’t write to me, pointing out all the errors in my unscientific reasoning. This was a simplistic exercise trying to somehow quantify the damage to visualize the loss a person may suffer.
Fannie Mae’s first move against strategic defaulters.
Today, Fannie Mae announced how it would deal with strategic defaulters: they will be punished by being unable to qualify for a loan for up to 7 years through Fannie Mae and the latter will reserve the right to take legal action to recoup the losses in states that permit deficiency judgments (not the case in California). The line has been drawn in the sand.
Strategic defaulters, or those borrowers who have the financial ability to pay their mortgages but who choose not to and walk away because the value of their homes are underwater, are becoming a big problem for banks as the stigma is becoming less and less meaningful and the distressed properties market is ever increasing. One study puts strategic default at 1/3 of all defaults which eventually lead to foreclosures.
Fannie Mae is addressing a big problem for itself and trying to force strategic defaulters to think twice before walking away from their mortgage obligations. It’s a perfectly understandable move on its part as it is trying to do potential future damage control. This reason is also why it has agreed to participate in the HAFA program guideline to encourage negotiated and approved short sales rather than have homeowners simply walk away. Fannie Mae and Freddie Mac have figured out it is better to work with the distressed borrowers and, for those who qualify, work out an agreed short sale resolution rather than have the property foreclose, as the loss to them will be significantly greater in the end. They are simply engaging in good business practices by mitigating their loss.
Foreclosure is not your only option. There are other alternatives which are less damaging for most homeowners.
What exactly is a Short Sale?
Simply put, it is when you sell a home for less than what is owed on it with the lender’s approval and the lender forgives you for the difference (what is short) between what is owed and for what it ultimately sells. The Federal Government is now pushing for this option for homeowners who are unable to obtain loan modification and offering lenders financial incentives to permit homeowners to choose this route.
Why would the lender agree to do this?
Money. It’s always about the money isn’t it? Typically, it is cheaper for the lenders if the house is sold prior to getting into foreclosure and being sold at auction. There are costly expenses associated with foreclosing on a home (aside from the fact that owners who are going through foreclosure typically destroy the homes before they are evicted); but with short sales, it takes less time (meaning less carrying cost for the lender) and makes more economic sense for lenders if the homeowners have an interest in and participate with the lenders in selling their homes, rather than fighting with them. The lender saves money because they don’t have to pay for eviction, go through an auction only to have to take the property back because the auction did not meet their floor price or no one attempted to bid, make repairs and then pay Realtors to sell it as a bank owned (REO) property which typically gets deeply discounted by buyers anyway, in the meanwhile, still paying for taxes, insurance, association fees, etc… that the seller failed to pay. A home where the seller still resides and maintains will fetch a much higher selling price than an abandoned eye-sore type of property.
Why would it be good for the seller?
It allows them to have control over their economic future and sense of dignity. Let’s face it, if you are contemplating foreclosure, that means your financial situation will not be changing for the better in the immediate future. Don’t let others dictate your financial future; get involved and control and participate in your own financial outcome.
The most important facet to the short sales process is that it permits you to have control over your financial future. If you are forced into a foreclosure situation, your credit score will be devastated as you had no participation with the lender to help address the situation. The net result will be more devastating than bankruptcy from the Fannie Mae Underwriting Guideline point of view and you will not be able to buy a home or apply for a credit card for many years; additionally, now more and more employers are doing credit checks on prospective new hires and a foreclosure on your credit history may put you in jeopardy, especially if the job requires security clearance status, is a government position or involves handling of money. And once you are forced out of your home, you will need to rent a property; with a foreclosure on your credit record, you will learn that finding a rental property will become more difficult and the down payment requirement will dramatically increase compared to people who don’t have foreclosure on their record. If you choose to take control and complete a lender approved short sale, you will be able to salvage your credit by more than halving the seasoning requirments (only 2 years) for Fannie Mae Underwriting Guidelines for re-establishing credit and give yourself the opportunity to be in a situation to buy a home again in a relatively short time. Naturally, individual sitautions will vary in results.
A mis-perception floating around out there is that the short sale Realtor works for the lender. That is absolutely wrong. The listing agreement is a contractual relationship between the seller and the Realtor; the lender is not a party to the contract and has no relationship with the Realtor. WE WORK FOR YOU and have a contractually obligated, fiduciary relationship with you! We look out for your interests.
Who pays for the commission?
Because you are facing financial difficulties, the lender is required to pay for the commission and associated closing costs for completing the short sale. (This is why some people believe the Short Sale Realtor works for the lender).
