The Effect of Investment Property Foreclosures on Credit

Foreclosures are bad, no matter what purpose the home served. Unfortunately, the lender who is foreclosing on the property does not treat an investment property any different than an owner-occupied property. Investment properties can be rental homes, but also can be office buildings, commercial property, warehouses or land. The fact is, when it forecloses, it is reported as a foreclosure on your credit, and your credit and scores are in for a bumpy ride of negative hits.

Risky Business

Investment homes are considered "high risk" and more difficult to obtain financing on. The reason: if a homeowner owned investment properties and his own home, and ran into financial difficulty, he would do all he could to save his family's home first, then the investment properties as second priority. It is for this reason that lenders have required a higher down payment on investment properties than owner-occupied homes, reasoning that if a home buyer puts more cash into a home at purchase, he will do more to protect his investment. This practice is an attempt at risk reduction on the part of the lender.

Multiples

Investors who make their living on investment and rental properties will usually own several homes or properties. The problem with investor foreclosures is that it is rarely limited to just one property. By the time her first home forecloses, she may be on a downhill roll which destroys her credit and scores. If she lives in a state that allows for collection of recourse deficiency, the investor is already en route to bankruptcy court.

Recourse

When a bank forecloses on a property, it will try to sell the home. If the auction sale goes well, and an acceptable price is offered, the home will be sold. Hopefully it will bring enough to cover what is owed plus all of the additional attorney fees and inspection costs. If not, the home may sit on the market. In the event the bank allows a "short sale" (sold for an amount that does not cover all of the payoff amount), the foreclosed homeowner may receive a bill for the short sale deficit. Loans where unpaid deficits can be collected are known as "recourse" loans. Most investor loans are recourse loans, since they would not have private mortgage insurance (PMI) protection. In addition to the foreclosure, the recourse amount may end up as a collection item, then a judgment on your credit report, further damaging your credit and scores.

Second Mortgage

In the event a foreclosure occurs on a home where there is a first mortgage and a second mortgage, there may not be enough funds generated in the sale of the home to pay off all of the costs of the first mortgage and the second mortgage. If both liens are not satisfied, the second mortgage lender may come after you for the recourse deficiency, which can become a collection item, then a judgment against you on your credit report.

Anti-Deficiency

All states vary, but there was a set of laws established way back in the Great Depression. These "anti-deficiency" laws surround aspects of recourse collections, disallowing the recourse deficiency to attach to the owner's other assets (like his home). You must check with an attorney to find out if your state has adopted anti-deficiency laws, or if you are subject to losing other assets in the event of a foreclosure where there is recourse.

Considerations

An investor who is approaching foreclosure on her properties should try to work out a compromise with her bank. Try a loan modification with your lender if possible. Offering to do a "deed in lieu of foreclosure" before the account status gets so far deep in trouble may be the best solution to salvage your credit. There will be a negative hit, but it won't be as bad as an actual foreclosure. Conventional lending (Fannie Mae and Freddie Mac) dictates a 5-year wait and credit reestablish period of time before they will consider granting more investor loans where there has been a foreclosure. FHA has a 3-year wait and reestablish period before another loan can be granted. (Note: FHA does not participate in investor financing anymore).