Foreclosure, Short Sales and your credit, be educated!

Which is the lesser of two evils: foreclosure or short sale when it comes to your credit? 

Foreclosure:you lose your home and your credit score drops 200-300 points as it will show mortgage lates resulting in a foreclosure. It will be a few years before you can secure that American dream of home ownership again.

Short Sale: you owe more than your house is worth but the lender, which approves the sale, receives the proceeds from the short sale and the debt is considered settled (sometimes).  The tricky part is how you negotiate with your lender as to whether your credit will be tarnished.

Let me state up front that not all short sales go smoothly.  And, what happens to your credit depends on how your lender reports the liability to the credit agencies. 

It is imperative that you negotiate the reporting terms with your lender.  The lender can report your account:

• satisfied - credit should be okay, lates will affect your score
• unreported - credit should be okay, lates will affect your score
• delete it - you are VERY lucky
• or settled for less than the full amount - this WILL negatively affect your score

How big a credit score hit also depends on your credit history.  Do you have a number of other accounts in good standing with a long credit history?  If you do, you will be better off.  What will happen though is that your credit profile will make you a higher risk to future lenders or others that may look at your credit score (insurance, credit cards, rentals, etc.)

Is the debt settled upon a Short Sale?

In most cases, the remaining unpaid debt is forgiven by the lender and written off as a loss.  The Mortgage Forgiveness Debt Relief Act of 2007 removes the tax liability from $1 million or less of debt forgiven on a primary residence during 2007, 2008, and 2009.  Prior to this Relief Act the forgiven debt was taxable as regular income.  Now, the tricky part is that most homeowners will qualify for the tax break IF the lender chooses to write off the debt.

So, when negotiating with the lender, make sure the debt will be forgiven.  The lender can sue after the short sale for the unpaid balance.  If you do not receive a written promise to forgive the debt you will still be liable for the remainder of the loan.

And, to wrap it all up remember a short sale is not for everyone - the lender will request proof there is a real financial hardship, and probably won't agree to a short sale unless you are behind on your mortgage payment.

Unfortunately, a short sale may be the option you need - just make sure you are getting professional assistance.

This is written as my personal opinion not as professional advise.