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!’  As you may have learned is an article I wrote titled How Does a Short Sale Affect my Credit Score, the score itself is not better off with a short sale versus a foreclosure.  But at least in a short sale situation you have the option to keep payments as current as possible which can minimize the score destruction.  However, there are two key items that prove a short sale to be a better option than the foreclosure.

 

As described in detail in the following article How Does a Short Sale Affect My Credit Report, the report itself will usually reflect language that is far less serious than the word “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

• Need a short sale? Have one of our certified short sale specialists help you. SELL YOUR HOUSE NOW
• Have a short sale that is going nowhere? Have one of our certified short sale specialists help you. SELL YOUR HOUSE NOW
• Want the best in the business to help you with your short sale? Have one of our certified short sale specialists help you. SELL YOUR HOUSE NOW

Comments

1. laureen hobbs says:

   January 29, 2010 at 1:56 pm

   I am in a short sale with a closing date of feb15 2010. they are forgiving me 89,000 and will release the lien for a sale. this is going to give me at 30,000 shortage. bank of america sent me a letter they want me to sign saying remaining bal would be a charge off on my credit and they will contact me for payment arangements. this sanario is not in theses articles.
2. Phil Pustejovsky says:

   January 29, 2010 at 2:21 pm

   My first question would be…are you working with one of my students? Oftentimes, only the most highly skilled in the short sale world can negotiate the best deal for the homeowner.

   But your situation is not the worst it could be. The worst would be a foreclosure whereby you have a $89,000 + $30,000 deficiency that you would have to pay back as well as a foreclosure on your credit report. This short sale you are going through is STILL better than a foreclosure, to the tune of saving $89,000 and not having a foreclosure on your record.

   So this article’s advice still hold true in your situation.

   My only solice for you is to seek the best in the short sale business to work with you. I just closed a deal last week and the homeowner did not have to pay the $65,000 shortfall, even though it was a HELOC and USBank was adamant about holding him responsible. It took some high level negotiations to get USBank to not hold him responsible.

   The right short sale person could probably negotiate a better deal for you.
3. Diana Nickel says:

   February 27, 2010 at 3:54 pm

   It sounds good so far. . .I am completely new here and am just getting familiarized with real estate investing with respect to short sales. I do like the idea of negotiating a deal in which the purchaser is left without the responsibility of paying for an over priced home they no longer own and allows me to earn income at the same time. . . thank you.
4. Jessica says:

   June 29, 2010 at 2:42 pm

   What do you say when the short sale approval letter includes language that indicates that, while the seller does not owe anything at closing, the bank retains the right to pursue a deficiency judgment? The bank in question is Bank of America. What are the odds they WILL pursue it? Also, if the closure happens in July, will we receive a 1099 in January? If so, does that mean they cannot pursue deficiency? If not, does that mean they are considering pursuing deficiency?
5. Phil Pustejovsky says:

   July 8, 2010 at 8:24 am

   Odds? You’re dealing with banks who are by nature, greedy. The best thing to do is negotiate with Bank of America BEFORE you close the short sale and send them money. The little dirty secret banks are not telling homeowners is that many have the plan of staying quiet after a short sale while maintaining their rights to pursue the difference. Then, a few years down the road, after the homeowner is back on their feet financially, then they will attack. Therefore, it is better to NOT give the bank to pursue you.
6. Kitty says:

   July 16, 2011 at 8:50 am

   We did a short sale in 2009. The approval letter from Bank f America said that they and their investors may pursue a deficiency judgement for the difference in payment received and total balance due. My question concerns the line of credit amount for the 2nd mortgage. The conditions of the short sale approval listed that the maximum allowed to the Jr. Lein Holder was $3000 and the Promissory note was for $0.00.
   Bank of America is now having a collection agency come back for the full amount of the deficiency on the 2nd mortgage. What do yu suggest?

Trackbacks

1. HUD Releases FHA Guidelines for Short Sale Borrowers : Short Sales Step By Step Blog says:

   December 19, 2009 at 8:10 pm

   [...] One of the biggest myths in the real estate world right now is that a foreclosure is just about the same as a short sale.  I’ve heard appraisers, agents, even mortgage brokers echo this sentiment.  Nothing could be further from the truth.  There are tremendous benefits for a homeowner to do a short sale over letting a property go to foreclosure.  Refer back to another I article I wrote on this topic, titled “Is a Short Sale Really Better Than a Foreclosure?”  [...]