Short Sale vs Foreclosure - Which One Should You Opt For?

Short sale vs foreclosure… Both terms are all over the news. But what does each one mean? And how does each one affect you as a homeowner?

For starters, let's go over the difference between short sale and foreclosure:

A foreclosure happens when you fall behind on your mortgage payments, and the bank takes possession of your home. Usually, if you have missed more than four mortgage payments, the bank will start foreclosure proceedings.

Once the bank legally takes possession of your home, it will turn around and sell it - typically, at a price that is well below market value, simply because the bank doesn't want to have to deal with the house anymore.

A short sale, on the other hand, is what many homeowners will do to avoid a foreclosure. Since going through a foreclosure process is difficult for both banks and homeowners, both sides will usually do everything they can to avoid it.
 
In the case of a short sale, a homeowner who is in financial trouble will get the bank's permission to sell the home at a price that is less than what's actually owed on the mortgage. A short sale gets its name from the fact that the selling price falls short of the amount of money that's owned to the bank.

Why would a bank agree to a short sale if it's going to lose money on the deal?

When a bank decides to do a short sale, it's because it doesn't want to have to worry about taking possession of the house and turning around and selling it. The bank may not get all of the money that it's owed in a short sale, but it doesn't have the headache of selling the house, either.

How to write a hardship letter for short sale

So, how do you get the bank's permission to do a short sale?

You will have to start by writing a short sale hardship letter to the bank. This letter is what the bank will use to either approve or deny your short sale, so it has to be good. A good hardship letter for short sale will explain why your financial situation has changed since you got your mortgage. There can be all kinds of reasons —like getting laid off from your job, being unable to work because of a cancer diagnosis, or a divorce, just to name a few.

A short sale hardship letter should also explain why there is no hope for improvement in your financial situation. For example, if you're getting divorced, you will now be living off of one income —instead of the two incomes you had when you got the mortgage. In that case, your financial situation isn't going to get better anytime soon!

Your hardship letter for short sale should also point out the fact that you have no disposable income - or, no extra money that you can use to pay your mortgage. It may sound depressing, but a good short sale hardship letter needs to make your financial situation look as horrible and hopeless as possible.

Short sale vs foreclosure tax implications

But is a short sale really the best choice? In the game of short sale vs foreclosure, which one is right for you?

There can be short sale tax implications, so before you try to get one, talk to a lawyer or a tax professional. The exact short sale tax implications that you deal with will depend on what state you live in and how long you have owned your home.

In some cases, the IRS may see your short sale as loan forgiveness - meaning that you could have to pay taxes on the amount of money that the bank forgave. If that's the case, you will get a 1099-C in the mail.

However, foreclosures come with tax implications of their own, too. If the bank decides to write off the money you never paid in mortgage payments as a tax deduction, you will have to pay taxes on that amount. There are some federal regulations in place to give foreclosed homeowners a tax break, but they will only last until 2013 —and they only apply to your primary residence. If you have a second home (like a rental property or a vacation home) that gets foreclosed, you won't get to take advantage of any tax breaks.

But the differences between these two have to do with more than taxes!

Vital difference between short sale and foreclosure - Your credit score

In fact, one of the biggest differences between a short sale and foreclosure has to do with how long you have to wait to buy another home.

With a short sale, you can usually buy another home 24 months later and still get a decent interest rate. With a foreclosure, you will need to wait at least 5-7 years before you can buy another home.

Another big difference between a short sale and a foreclosure has to do with your credit. The initial effect on your credit score will be very similar. Whether you go through foreclosure or a short sale, expect your credit score to drop anywhere from 85 to 160 points right off the bat.

With a short sale, though, you won't have the long-term damage to your credit report that a foreclosure brings. Simply seeing the word foreclosure on a credit report will turn off the majority of lenders.

While neither one is particularly pleasant, knowing the difference between short sale vs foreclosure can put you in a position to better protect what little finances you have left. By understanding how each one will affect you, you can make a decision that's right for you!

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