Consequences between a short sale and foreclosure

Many homeowners get frustrated trying to figure out how to resolve the fact that their mortgage is underwater. There are many homeowners that are just walking away, however this can be a mistake. A homeowner can ask for a short sale even if they are not late on their mortgage, but the reality is that a lender has no incentive to allow a short sale if payments are still being made on time. If you are in this position then you should spend the time exploring all options before walking away.

Two of the most important reasons to find a way to resolve the situation will be the impact to your credit rating, and having to deal with lenders chasing you for any unpaid mortgage balances.

Foreclosure Impact

Credit Score: Drops score approximately 200-250 points

Length of Time on Credit Report: 7-10 years

Buying another home: Disqualified for a mortgage for at least 3 years and may take as long as 7 years.

Interest Rates: Revolving credit accounts, auto loans, short term loans will all have higher interest rates and most likely a reduction in credit offered.

Short Sale Impact

Credit Score: Drops score approximately 60-100 points

Length of Time on Credit Report: approximately 7 years

Buying Another Home: Qualify for a mortgage with a decent interest rate after approximately 18 months

Interest Rates: Revolving credit accounts, auto loans, short term loans will all have higher interest rates and most likely a reduction in credit offered, but the time for credit recovery is much less than for a foreclosure

The main point that homeowners need to realize is that if they are successful with doing a short sale to get out of their situation, the road to credit recovery is shorter than if they went to foreclosure. Protecting your credit score will also help in minimizing the amount of interest you pay on future credit cards and loans.

Deficiency Judgments

Regardless of a foreclosure or a short sale, there will always be a concern on whether or not the lender will come after the homeowner to collect any unpaid mortgage balances.

If a lender cancels debt that you owed, a 1099-C may be received. The amount reported on this form is considered taxable income by the IRS, unless insolvency can be proved at the time the debt was cancelled. It has been said recently that more homeowners have been receiving a 1099-C.

One of the main reasons to try a short sale, and give it your best effort is that it can reduce the amount of deficiency you would be liable for when filing your taxes.

There are some states that do not allow lenders of 1st mortgages to pursue a seller for the unpaid balance. Second liens and equity credit lines may still be able to pursue the seller unless an agreement has been reached and a release of lien has been issued. Borrowers may have to pay tax of any unpaid mortgage balance unless they meet IRS's home exclusion or insolvency rules. Always check with your CPA or professional tax advisor to discuss the impact on federal taxes before taking action on any financial decisions.

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