Short Sale vs. Foreclosure

Howeowners facing foreclosure often wonder if a “Short Sale” is a better alternative.  The truth is that it really depends on the distressed homeowner.  Each homeowner will have a unique situation that should be reviewed with a professional that is familiar with the process and the implications of both a Foreclosure and a Short Sale.

Items that are considered important factors to be considered by the homeowner and the professional evaluating the situation:

  • Financial situation of the homeowner
  • Homeowner’s priorities
  • Goals – Does the homeowner have a goal of purchasing a new home once they get back on their feet?
  • Adversity towards risk
  • Property condition
  • Market conditions
  • And many other factors

Below is a comparison of a Short Sale vs. a Foreclosure to help you understand how they differ.  It is important to realize that this list is meant as a guideline and that we cannot stress enough that your situation could be unique.  It is always best to review your property and situation with a professional.

FACTORS FORECLOSURE SHORT SALE
Definition If you default on your loan, Foreclosure is the legal process that the lender may use to sell your property to satisfy the debt you owe.  A short sale is a sales transaction where the seller’s lender voluntarily agrees to receive a loan payoff for less than what’s owed.
Credit Foreclosure and short sale have the same negative impact on your FICO score, according to myfico.com.  The derogatory item stays on your credit for 7 years, but your FICO score may begin to improve after 2 years if you keep your other credit obligations in good standing.  Aside from your FICO score, whether foreclosure or short sale is better for your overall credit-worthiness depends on the purpose for which you’re using your credit, such as mortgage loan, auto loan, credit cards, apartment rental, or job application. (see right column).  A short sale may be reflected in your credit as an account that is “not paid as agreed” or settled for less, and has the same negative impact as a foreclosure on your FICO score according to myfico.com. However, a short sale may be better than foreclosure for obtaining a new mortgage loan under current Fannie Mae guidelines.  According to Fannie Mae, only 2 years must lapse after a short sale for a borrower to show reestablished credit, whereas 5 years must lapse after a foreclosure (or 3 years if borrower can prove hardship or extenuating circumstances).
Tax  1. Cancellation of Debt: Foreclosure may give rise to taxable income to you for cancellation of debt, which is roughly calculated as your loan balance minus your property’s fair market value at foreclosure.  Certain exceptions apply, such as bankruptcy, insolvency, forgiveness of a non-recourse loan (IRS), and a loan for purchasing or substantially improving qualified personal residences.

2. Capital Gains: Foreclosure may also give rise to taxable income for capital gains, which is roughly calculated as your loan balance (or the property’s fair market value) less your original purchase price and major improvement costs.  However, you generally do not have to pay taxes on capital gains up to $250,000 (or $500,000 for married couples filing joint returns) if you owned and used the property as your principal residence for at least 2 of the last 5 years.

 1. Cancellation of Debt: As with Foreclosure, a short sale may give rise to taxable income for cancellation of debt, but the calculation is different.  For a short sale, the cancellation of debt income is roughly your loan balance minus the sales price.  Certain exceptions apply, such as bankruptcy, insolvency, and a loan for purchasing or substantially improving your qualified principal residence.

2. Capital Gains:  As with foreclosure, a short sale may give rise to taxable income for capital gains, but the calculation is different.  For a short sale, the capital gains calculation is roughly your selling price minus your original purchase price and major improvement costs.  As with a foreclosure, you generally do not have to pay taxes on capital gains up to $250,000 (or $500,000 for married couples filing jointly) if you owned at used the property as your principal residence for at least 2 of the last 5 years.

Personal Liability  If your loan balance is more than the foreclosure sales price, you generally will not be personally liable for the difference under certain circumstances, such as if the lender forecloses non-judicially through a trustee’s sale or if you have a purchase-money, owner-occupied loan for one-to-four residential units.  Certain exceptions apply, such as loan fraud, intentional property damage, certain wiped-out junior liens, and FHA and VA loans.  If your loan balance is more than the sales price of your property, whether you’ll be personally liable for the difference may depend on what you negotiate with the mortgage lender.  Your lender may agree to forgive you for the shortfall, refuse to forgive you for the shortfall, require you to repay the shortfall, or say nothing about the shortfall.  If the lender agrees to forgive you for the shortfall, make sure to get that agreement in writing and signed by the lender.
Possession  You generally have the right to stay in your home during the foreclosure process which takes a minimum of about 4 to 5 months.  If you do not leave after a trustee’s sale of the property, the new owner may negotiate a cash-for-keys agreement with you,  commence the eviction proceedings by serving you a 3-day notice to vacate, or take some other action.  You generally have the right to stay in your home until you close escrow on a short sale transaction.  You may, however, be able to negotiate with the buyer for a longer or shorter stay.
Personal Concerns  The foreclosure process does not take much effort on your part, but the wait can be agonizing and stressful for certain people.  Although non-judicial foreclosures take a minimum of about 4 to 5 months, you generally cannot dictate how quickly the lender proceeds with each step of the foreclosure process.  You may also feel uncomfortable with what you may perceive as the shame or stigma associated with foreclosure such as when a notice of trustee’s sale is posted on your property or the sheriff comes to escort you and your family out of the property.  Doing a short sale may involve a lot of time, effort, and paperwork on your part to list and market your home, to get your lender’s approval, and to consummate the sale with your buyer.  Yet, during this process, you generally do not know whether you will succeed in closing your short sale transaction.  Despite the hard work and uncertainty, you may prefer a short sale because it allows you to take a proactive approach to finalizing this chapter of your life so you can move on to the next one as quickly as possible.
Assistance  To assist you, a foreclosure consultant as defined under Cal. Civ Code SS 2945.45 must registered with the California Department of Justice and bonded for $100,000.  Real Estate licensees are generally exempt from this requirement. One big advantage of a short sale is you can hire a professional real estate agent to help you through what can otherwise be a complicated and difficult process.If you need assistance with your short sale please contact us at 800-683-0002 or via email at VIPClients@BullMarkREG.com