The first, second, third, maybe even fourth wave of foreclosures has come and gone. Some markets have fired back already, but in many more areas, the market has had, at best, a half-hearted attempt at recovery.
That leaves small-business owners who own their homes left holding houses that are underwater, owing much more than the houses are worth. Unlike the other waves of foreclosures, these homeowners can often afford the payments. But they are looking at years before the value increases to break even with the debt. So does a strategic walkaway make sense for you and for your business?
If you’re in this position, there are steps to go through first to make sure a strategic walkaway is best for you. Your credit score will be impacted. You may have to live with the consequences of this action for seven years. That’s the length of time that derogatory information will stay on your credit report.
If you are looking into walking away from your underwater property, you have a few options. You could let it go to foreclosure, attempt to negotiate a deed-in-lieu of foreclosure, or participate in a short sale on the property. It has become increasingly more difficult to negotiate a deed-in-lieu with lenders. They would prefer that you do a short sale, or let them take the property in foreclosure.
So generally the choice comes down to which will give you the best options down the line, and that means which method will impact your credit the least.
In the case of a foreclosure, you can expect a loan that is or was in foreclosure to appear on your credit report as a ‘foreclosure.’ There is no such single, universally accepted description for a short sale on a credit report. Your credit report may state that the loan had a ‘charge off,’ it was ‘settled for less than the full amount due,’ or even ‘foreclosure.’ These all have about the same negative impact on your credit score as a foreclosure.
The actual amount of impact will have to do with the dollar amount of the defaulted loan. The higher the dollar amount, the bigger the negative impact on your credit score.
When a foreclosure is reported by a lender to the credit reporting agency, the amount showing upon the report will show the entire unpaid loan amount at the date that it went into foreclosure. In the case of a short sale, a different calculation is used. The reported amount will be the outstanding loan amount as of the default less the sales price received by the lender.
As an example, let’s say you have a property with a loan of $350,000. The property is now worth about $150,000, so you are walking away from it. If it is foreclosed on, the loan amount of $350,000 will show as a default. If it is sold through a short sale, the amount shown will be $200,000, calculated as the default loan amount less the sales price received. Since your credit score is negatively impacted based on the amount of defaulted loan, the short sale will have less of an impact.
A short sale might have a slightly less damaging credit hit, but the benefits are likely to be just short term.
There is one more item to consider regarding your future borrowing ability. If you have had a foreclosure, you will have a time out before you can qualify for many types of new mortgage loans.
There is a lot to consider before you start a strategic walkaway from a property. The credit hit may be worth it if it means you are getting out from under a bad loan and an underwater property. But you’ll never get away completely unscathed — and chances are, your personal credit will affect the creditworthiness of your small-business ventures, somewhere down the road.