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Chapter 2: Short Sales vs. Foreclosure Properties (full)

Chapter 2: Short Sales vs. Foreclosure Properties – What is the Difference?

For struggling homeowners, short sales are an alternative to foreclosureBoth borrowers and buyers will find that short sales present different advantages and challenges. For homeowners, the decision between choosing a foreclosure or a shortsale will depend on their specific circumstances. Of course, before making that decision, it is important to thoroughly investigate both options and understand the differences between them.

In the previous chapter, we discussed the definition of a short sale and how it works. It is also important to understand foreclosures and how they work. What is a foreclosure? When a borrower fails to make their home mortgage payments on a regular basis, the property may be foreclosed upon, which means that the lender evicts the borrower, taking ownership of the property. These properties may be sold via real estate agent or at an auction.

Short sales offer an alternative to foreclosure in many instances, which may offer benefits to both the borrower and the creditor. Here is a closer look at the difference between a short sale and foreclosure, as well as how those differences affect homeowners, lenders and buyers.

Short Sales vs. Foreclosure Properties – When are They Used?

First, when comparing short sales vs. foreclosure properties, it is important to understand when both of these options are used. When it comes to foreclosures, they are generally used when the borrower on a mortgage has defaulted on their payments.

Although a short sale may be used when a borrower defaults on mortgage payments, it can be used in other situations as well. These transactions can also be used when borrowers think they will be unable to make future mortgage payments. Short sales may also be used if a homeowner owes more on the home loan than the home is currently worth. However, no matter the situation, a lender must agree to the transaction for it to move forward.

Comparing the Benefits of Shortsales vs. Foreclosures

Benefits of short salesWhen looking at the differences between foreclosure properties and short sale homes, the differences can be seen in the benefits that each option has to offer. One of the benefits of a short sale versus a foreclosure is that homeowners can stay current on payments while working to go through with a shortsale transaction. This helps to avoid the credit damage that comes with missing payments and going into default.

Short sales also offer sellers the benefit of having more say in the sale price of the home. It is in the best interest of the seller to get as high of a price as possible to avoid owing money on the loan after the sale. However, even though you may have more say in the final sale price, the offer still has to be approved by the bank.

Many homeowners find that a short sale offers the benefit of avoiding the social stigma that often comes with going through a foreclosure. No one enjoys the stigma of having a home foreclosed upon, which makes these transactions beneficial to many individuals.

Homeowners that choose shortsales also have the benefit of being able to buy a house more quickly. If payments have not fallen more than 30 days behind and the lender does not require a deficiency judgment, it may be possible to buy another home fairly quickly. Keep in mind, it may be a bit more difficult to find a lender to fund the loan. Of course, when compared to buying after a foreclosure, a shortsale has many benefits. After going through a foreclosure, it may take 5-7 years before a home can be purchased again.

Potential Tax Consequences of Both Options

The potential tax consequences of foreclosures and short sales must be considered when looking at the differences between the two options. Currently, legislation relieves short sellers of facing Federal tax consequences. While the amount of the loan forgiven by the lender is technically considered to be income by the IRS, this tax burden is eliminated. However, state local taxes may apply.

Foreclosures also fall under the same legislation. Debt relief was offered until the end of 2012. However, new legislation has provided an extension of that relief until the end of 2013. After a foreclosure, a bank could issue you a 1099 and you may also be responsible for local taxes, depending on the specific tax codes in your state. Individuals going through foreclosure should hire a tax accountant for assistance.

Short Sales vs. Foreclosures and Your Credit Report

Foreclosures badly affect a homeowner's credit; short sales have less of an impactShort sale transactions and foreclosures differ from one another in how they affect a homeowner’s credit report as well. When analyzing the differences between the two, consumers must realize that both processes will result in negative information being reported to credit reporting agencies. This means that this negative information will end up on the consumer’s credit report and affect their credit score. With a short sale, homeowners will see an impact on their credit score, even if payments on the loan are not missed. After the transaction takes place, lenders will report either “settled for less” or “paid in full for less than agreed” to credit reporting agencies. This notifies other potential creditors that you were unable to meet the mortgage obligation. Of course, when compared to foreclosures, it is easy to see that foreclosure have a more drastic negative impact on a homeowner’s credit score and credit report. The resulting drop in a consumer’s credit score will depend upon the total amount of payments missed. In many cases, foreclosure can lower a credit score by more than 200-400 points. Foreclosures also are listed on a homeowner’s credit report for seven years. Not only can a foreclosure keep consumers from being approved for credit in the future, but also some employers look at credit reports and will not hire individuals with foreclosure on their record.

Deficiency Judgments – Shortsale vs. Foreclosure Property

In a short sale, the lender and the seller often negotiate deficiency judgments.When it comes to deficiency judgments and a short sale, the lender and the seller often negotiate these judgments. In many cases, lenders are happy to forgo deficiency judgments just to get the property off their hands. In certain cases, if the home is the personal residence of the seller and was financed through purchase money, no deficiency judgment is made.

Foreclosures differ greatly from short sales in this area. In most cases, after a foreclosure, lenders are unwilling to negotiate the deficiency judgment. When foreclosures take place under a judicial foreclosure, deficiency judgments may be filed in many cases. Consumers that go through foreclosure are often more likely to end up dealing with a deficiency judgment than those that choose the short sale option.

Shortsales vs. Foreclosures and Your Loan Applications

Later, after a homeowner moves on from a shortsale or a foreclosure, certain differences may be seen once again. For example, when a consumer is planning to apply for a loan, certain questions may be asked about foreclosures. When filling out loan applications, no questions are asked about short sales and consumers are able to report that their home was sold. However, a common question on loan applications is: “Have you ever had a property foreclosed upon or given a deed in lieu thereof in the past 7 years.” Consumers have to answer these questions truthfully, since lying on an application can result in FBI investigation for mortgage fraud. Of course, when consumers note that they have gone through a foreclosure within the past 7 years, most loans end up being denied. Short sale transactions and foreclosures have many differences, which should always be carefully considered before making a decision between the two. It is often an excellent idea for consumers to seek tax and legal advice before making the final decision to avoid facing serious consequences in the future.

Next: Chapter 3: Pros & cons of short sales