Is a Short Sale Really Better Than a Foreclosure?
YES!’ 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.
The credit report itself will 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 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.
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 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 more 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.