A borrower that becomes delinquent on their mortgage, completes a short sale, gives the property back using a deed-in-lieu, or is foreclosed upon, will have their credit negatively impacted. The goal is to minimize the negative effects to your credit.
Negative impact on a credit report is generally limited to 7 years.
Current guidelines allow qualification for a Federal National Mortgage Association (Fannie Mae) insured loan 5 years after a foreclosure, 4 years after a deed-in-lieu, or 2 years after completion of a short sale.
Declaring bankruptcy to delay a foreclosure, or to wipe away a deficiency judgment after foreclosure, will impact the borrowers credit report for 10 years.
- A foreclosure will typically reduce your FICO score between 200-350 points.
Depending on the loan type, the borrower may owe the difference between the amount owed and the amount recovered at foreclosure auction (the deficiency). The owner may be able to negotiate a release in full, if they are able to complete a short sale. It is important to note that if there are multiple loans on the property, for example a 1st and a 2nd mortgage, and only one forecloses, the borrower will likely remain liable for the loan that did not foreclose, even though the borrower no longer has any ownership of the home. Many make the mistake of thinking the loan that did not foreclose must get a deficiency judgment in order to collect, but because they did not foreclose, their loan remains in full force and effect against the borrower—even if the lenders secured interest in the property was wiped out by the foreclosure.
In California, a one-action rule prohibits lenders from pursuing a deficiency judgment if the lender chooses to foreclose using the non-judicial foreclosure process (see Code of Civil Procedures 580b).
Purchase Money Rule
In California, the purchase money rule limits lenders that made purchase money loans to recovering their investment from the property alone, rather than the borrower. A purchase money loan is any loan used towards the purchase of the property, but does not include a refinanced loan. The theory behind this rule is that the borrower could not have purchased the property without the lender, and therefore the lender bears some responsibility as a party to the transaction. If you have a purchase-money loan that is being foreclosed upon, DO NOT sign a promissory note to the lender for your deficiency.
The prior owner or occupants will have to move after the sale, one way or another. Occupants refusing to move will only be faced with an unlawful detainer lawsuit, an eviction judgment, and forced removal by law enforcement. The new owner will likely also receive a judgment against the occupant, for market rents from the date of the auction sale to the eviction. Whether the prior owner, or a renter, it is usually best for the occupant to negotiate cash for keys with the new owner.
Cash for Keys
A buyer or lender at the foreclosure sale may offer cash to the prior owner or renter, to move quickly and leave the property clean. Cash for keys arrangements give occupants the resources to find new housing and is a great way to avoid the time and processing of an eviction.
A prior owner may receive a 1099 for the forgiven debt in the amount of the deficiency between the amount owed and the amount recovered at auction. Though recent law changes have eased the burden, this forgiven debt may be treated as income, resulting in state and federal income tax. The Mortgage Forgiveness Debt Relief Act (SB 401) was passed in California to account for the high number of homeowners the forgiven debt stipulation would have affected. The new law allows most taxpayers to exclude canceled mortgage debt income of up to $2,000,000 on their principal residence, or up to $1,000,000 for married individuals filing separately. It applies to debt forgiveness in 2009 through 2012. There are some exceptions though. Debt forgiveness on a second home mortgage, business property, or investment property does not qualify for exclusion under the new state law. Refinance loans that allow cash-out equity are also excluded.
*Tax implications are a critical consideration for homeowners in foreclosure, or those considering a short sale. You should consult a qualified tax professional for advice on your particular situation.
Some homeowners may find it necessary to file for bankruptcy protection to save their homes. Chapter 7 bankruptcy is a liquidation of assets and means any non-exempt assets you own will be sold and used to pay the creditors you owe. You are allowed to keep certain possessions and property when you file Chapter 7 bankruptcy. To find out which exemptions you are allowed to take, you should meet with a bankruptcy attorney. Chapter 13 bankruptcy is essentially a "wage earners repayment plan" where you are not asking the court to walk away from debt but to stop foreclosure and give you more time to pay the past due amount over 36-60 months. Chapter 13 is designed to allow financially troubled homeowners pay their bills, not necessarily wipe them out. Some homeowners will find themselves facing bankruptcy after foreclosure. Perhaps because the lender received a deficiency judgment against the borrower, or because a 2nd loan remains outstanding against the borrower after the foreclosure of a senior loan (even though that lender lost its secured interest in the property). Borrowers should fully understand these risks prior to allowing a loan to foreclose on their property.
Lease or Rental Agreements
Lease and rental agreements are generally treated as a lien against the property, and may be wiped out by the foreclosure of a senior lien. This typically leaves a renter in the position of becoming a holdover occupant after the foreclosure sale. While holdover occupants can typically not be locked out or forcibly removed, they typically retain no rights to continue on in the property and are subject to eviction. A number of laws have been enacted at the city, state, and federal levels that help renters by attempting to delay the eviction, typically through the requirement of an extended notice period prior to the new owner filing their unlawful detainer (eviction) lawsuit.
(Note: A portion of the information used on this page is courtesy of www.ForeclosureRadar.com , a subscription service that allows users to access Notice of Default, Notice of Trustee Sale and Bank Owned notices and proceedings. Feel free to reference their website for more information on the non-judicial foreclosure process.)