Should I do a short sale, or just let the bank foreclose? We’re asked that question more times than we can count. What’s the answer? Well, I hate to sound like an attorney, but the answer is “it depends”. It depends on a variety of factors that are specific to each person’s situation. In other words, the right answer for one person is not the right answer for anyone else.

One of the more significant questions to consider is this: If I lose the home in either a short sale or a foreclosure, or if I declared bankruptcy, when will I be able to get financing to buy another home?

Declaring bankruptcy, short selling, foreclosure, deed in lieu … any of these will require you to wait a certain amount of time before you can get financing to purchase a home.

How long to have to wait depends largely on how you lost your prior home and whether you had to file bankruptcy. The result is dictated by the FannieMae loan underwriting guidelines. FannieMae really isn’t in the business of loaning people money to buy houses. It is, however, in the business of buying loans from banks so that the banks can turn around and loan more money to more people to buy houses. FannieMae sets forth very specific underwriting guidelines that nearly all lenders follow. Why do they follow them? Because if they don’t FannieMae won’t buy that loan from the bank.

Under the 2011 FannieMae Selling Guide, there are waiting periods that restrict when a person can obtain a new mortgage loan if that person previously lost a home in a short sale, deed in lieu of foreclosure or foreclosure. The waiting periods also vary depending on how much money the person is going to be putting down. The periods begin to run from the date an action is completed, discharged or dismissed (that is, they would begin to run on the date a short sale is complete, a bankruptcy discharge is obtained, etc.)

In summary, the waiting periods are as follows:

Deed in lieu or short sale - as little as two years (with a 20% down payment) and up to seven years in certain cases.

Chapter 7 or 11 bankruptcy – 4 years (2 years in certain extenuating circumstances)

Chapter 13 bankruptcy – 2 years from the date of discharge, or 4 years from the date a case is dismissed (2 years in certain extenuating circumstances)

Multiple bankruptcy filings – if you’ve filed bankruptcy more than once in the last 7 years, a 5 year waiting period is required (3 years in certain extenuating circumstances)

Foreclosure – 7 years from the date of the foreclosure sale (3 years in certain extenuating circumstances, and then at least 10% down payment is required and a purchase can only be of a principal residence)

What’s an “extenuating circumstance”?  FannieMae defines it as follows:  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.

Looking at the above, it appears that in many cases having a chapter 7 bankruptcy on your credit file is no worse than a deed in lieu or a short sale.  So why, then, doesn’t everyone faced with losing their home just do a chapter 7 bankruptcy and end the stress?  Well here’s the rub.  If you file chapter 7 bankruptcy (or even chapter 13 or 11), you have not automatically eliminated the possibility of a foreclosure.  You’ve eliminated your personal liability for the promissory note, but your name is still on title to the real property.  In order to get title back the lender is going to have to seek relief from stay in the bankruptcy proceeding and then continue with the foreclosure.  In other words, you could end up with both a bankruptcy and a foreclosure on your credit file, in which case I suspect FannieMae would go with the longer foreclosure waiting periods.

Even if you go through bankruptcy, it often still makes sense to work with the mortgage lender on either a deed in lieu of foreclosure or short sale.

What to do?  Understand that bankruptcy and either a deed in lieu or a short sale are not mutually exclusive.  If you do one, it doesn’t mean that you cannot do the other.  It is not at all uncommon to proceed with a bankruptcy and at the same time short sell a home.  The most important thing to do is consult with legal counsel that knows something both about bankruptcy and real estate / foreclosures so that you can be properly advised on all of your alternatives and the consequences of any particular decision.