Foreclosure vs. Short Sale

In the current economic crisis, there are many home buyers who have found themselves unable to meet their mortgage payments. In this situation, there are basically two options for getting out of the contract agreement. Of course, either choice means losing the home and has some impact on the consumer's credit score.

By going the foreclosure route, the owner can stop making payments on the house, and may continue to live there until the bank or other mortgage holder decides to act. In a foreclosure, the bank is legally able to take possession of the property due to default in payments by the homeowner. Most banks would prefer not to use this option in most cases. There are many costs associated with foreclosure proceedings, and other costs to maintain the property once possession is taken. Foreclosed properties end up selling for a lower price, since the bank is interested in disposing of it to avoid further costs. Foreclosure will severely hurt a consumer's credit score, dropping it by up to a few hundred points. Today, with many pending foreclosures, it is possible that an owner can live in the house for years without making payments, as they wait for the lender to act.

 A short sale is probably a better option for most consumers than a foreclosure. This is only possible if the market value of the home has dropped below the mortgage balance and the owner is able to show that there is some legitimate hardship that has caused them to be unable to make their payments. In a short sale, the lender agrees to accept less than the current balance, and the owner must sell the property and move out. It is important to know that in a short sale, the lender may still obtain a judgement against the homeowner for the remaining balance or, if forgiven, may be treated as taxable income by the IRS. A lender does not necessarily have to report a short sale on a credit report, but if they do, it will generally impact the score a bit less than a foreclosure. Potential creditors may not treat them any differently however, and the short sale is listed as a pre-foreclosure on the report.