Is a Short Sale Really Better Than a Foreclosure?
With nearly 50% of all real estate transactions involving either a short sale or a foreclosure, many people have asked me if a short sale really is better than a foreclosure. And the answer is, "YES!' Here are two key items that prove a short sale to be a better option than the foreclosure.
Underwriters unanimously agree that the word foreclosure on a credit report is as bad as it gets. If instead, it shows, "Settled as Agreed", which sometimes happens with a short sale, although it is not as good-looking as "paid in full", it is far better than the word foreclosure. Many underwriting guidelines prohibit lending to borrowers who have foreclosure on their credit report. However, these same guidelines oftentimes do not have an problem with the phrase, "settled as agreed." In other words, a short sale is looked upon as a settlement, which usually takes 3 years to clear up. A foreclosure lasts 7 to 10 years. With the short sale, although the score itself is not necessarily better off, the fact that the short sale is recognized as a settlement on the credit report, as opposed to a foreclosure, is very helpful to a borrower.
We've talked at length about how a short sale impacts a credit score and a credit report. But there is an even greater reason why a short sale is a far better option than simply allowing a foreclosure to take place. A nasty financial term called a deficiency is the result of a lender losing a portion of their investment and then turning around and trying to collect from the borrower the amount of the short fall. With a short sale, the deficiency amount is usually far less than with a foreclosure. When a property becomes a foreclosure, it typically fetches less from buyers because the word foreclosure is attached to the listing. Buyers interpret a foreclosure as ripe for the picking and purposely offer less. The less the property sells for, the larger the deficiency and the more the borrower is responsible for paying back. Ouch!
With a short sale, most lenders do not attempt to collect on the deficiency, opting instead to simply issue the borrower a 1099C Forgiveness of Debt Form. This is an IRS requirement. Any lender who forgives debt above $600 must issue the forgiven party a 1099C. Thankfully, for most borrowers, the Mortgage Forgiveness Debt Relief Act of 2007 is their get-out-of-jail free card when it comes to this 1099 issue. For a minority of borrowers who have to do a short sale on an investment property, an intelligent professional tax advisor who understands insolvency is the best shot at circumventing the tax consequences of a 1099. In either case, a 1099 is almost always a better route to take than a deficiency. If a true deficiency is acted upon, as is common when someone lets a property go back to foreclosure, it can result in a judgment that a court can order to be collected upon through garnishment of wages. That's scary.
In summary, a short sale is much better than a foreclosure for three reasons. The first reason is that most lenders report a phrase besides foreclosure to the credit bureaus. Second, the typical short sale result in a 1099 as opposed to deficiency. And third, the amount the lender loses is usually far mroe with a foreclosure. When you combine these three major items, it's clear to see that a short sale really is better than a foreclosure.
ATTENTION HOMEOWNERS
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