How Does a Deed in Lieu Of Foreclosure Affect the Borrower’s Credit?

Most lenders report a deed in lieu of foreclosure as a foreclosure, so the credit scores will carry the same serious effect as if it were an actual foreclosure. However, borrowers 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 as you now realize, 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 100 points in addition to the points already lost for delinquent payments.
• Foreclosure – See above.

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

The current guidelines from Fannie Mae & Freddie Mac state that 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, the waiting period is 2 years from the date the proceeding is completed.

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Deed In Lieu Of Foreclosure

One option 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 obtain 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.

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 parole 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.

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How Long Before You Can Buy Another Home After Foreclosure?

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

However, if extenuating circumstances caused the borrower to enter into a foreclosure proceeding, such as the sub prime mortgage crisis fallout, loss of employment or a severe medical crisis, the waiting period, if approved, is 3 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.

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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.

Unless a foreclosure becomes a public record, such as a judgment, it can only be reported on a credit report for 7½ years from the date of the first late pay that led to foreclosure. Many consumers and lenders believe that it is 7 years from the completion date of the foreclosure process, but that is inaccurate. A foreclosure falls under the same rules as a collection, charge-off, or other similar action.

A foreclosure can drop credit scores from 50-250 points (this includes points already lost due to delinquent payments). The difference in point loss depends on how many points someone has to lose in the payment history factor of his or her credit report. Thus 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, credit scores can drop an additional 100 points.

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Foreclosure

Foreclosure is the legal process by 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 one’s property. It gives the lender a legal right to collect the remainder of debt out of the borrower’s other existing assets. 

However, there are exceptions to this rule. If the mortgage is classified as “non-recourse debt,” then in the event of foreclosure the borrower has no personal liability. This is often the case with residential mortgages. If so, the lender may not go after the 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 are not. 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 even if it can be considered “forgiven debt.”

Any other loans taken out against the property being foreclosed (second mortgages, home equity lines of credit) 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.

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Homeowner Options & How They Affect Credit Scores

Foreclosure, Deed in Lieu of Foreclosure, Short Sale, and Bankruptcy can all have long-lasting impact 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.

The following is a breakdown of homeowner options, and how each affects the credit scores. There are several loan products available, but, as previously mentioned, Fannie Mae & Freddie Mac own or guarantee about half of the U.S.’s mortgage market, so it is best to use their most recent Selling Guidelines as laid out in their June 25, 2008 Announcement.

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You May Have Extenuating Circumstances & Not Know It!

In most cases, homeowners who are facing mortgage default will at some point want to purchase a new home, however, there are specific waiting periods put into place to make sure that consumers have enough time to rebuild and re-established good credit.  The good news is that for consumers who are being forced into mortgage default due to extenuating circumstances, those waiting periods are reduced. 

Here is the definition of Extenuating Circumstances as it appears in the 2010 Fannie Mae & Freddie Mac Guidelines:

Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.

If a borrower claims that derogatory information is the result of extenuating circumstances, the lender must substantiate the borrower’s claim. Examples of documentation that can be used to support extenuating circumstances include documents that confirm the event (such as a copy of a divorce decree, medical reports or bills, notice of job layoff, job severance papers, etc.) and documents that illustrate factors that contributed to the borrower’s inability to resolve the problems that resulted from the event (such as a copy of insurance papers or claim settlements, property listing agreements, lease agreements, tax returns (covering the periods prior to, during, and after a loss of employment), etc.).  

The lender must obtain a letter from the borrower explaining the relevance of the documentation.  The letter must support the claims of extenuating circumstances, confirm the nature of the event that led to the bankruptcy or foreclosure-related action, and illustrate the borrower had no reasonable options other than to default on their financial obligations.

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