To short or Not to Short....part 2

One common belief is that a short sale is better on your credit report than a foreclosure. While a foreclosure on your credit report is terrible, a short sale may be just as damaging as a foreclosure to the seller's credit or credit rating. Both FICO and VantageScore have release recent studies that show "For anyone, a short sale can be almost as destructive as a foreclosure." FICO looked at how a short sale or foreclosure would affect three hypothetical mortgage holders: One with a 780 score; another with 720, who may have; and a third with a 680. In a short sale, assuming that the lender or servicer has waived the right to collect the difference between the amount owed and the amount paid, the 780 score drops to between 675 to 655; the 720 score drops to between 625 to 605; and the 680 score drops to between 630 to 610.

The biggest impact on a mortgage holder's credit score is missed monthly mortgage payments. If a person with a credit rating of 780 is 30 days late, the score drops as if a short sale has occurred (690 to 670). The same is true for the person with a 720 score (650 to 630) and a person with a 680 score (620 to 600). Thus, a short sale or foreclosure has almost the same credit rating effect if the seller is behind on the monthly mortgage payments.

Belief #2: The bank will not pursue a deficiency judgment. While some lenders clearly disclose in their short sale approval letters that a deficiency will not be pursued, others are less blatant. I have heard Realtors say "Oh, don't worry, they say they can come after you for the remaining balance but they never do.". Well.....the lenders might not be coming to collect the remaining balances right now, but right now they are quite busy. What happens when they no longer have all these short sales to process and their employees need something to do? Well, my bet is all those sellers who didn't have a very clear release of money owed will be hearing from some agressive collection agencies. These collection agencies will buy up these old debts for pennies on the dollar and will do all they can to collect the remaining balances. Debtors will have a choice of paying the debt in full, possibly settling the debt, or filing bankruptcy.

Belief #3: You won't be taxed on the amount of debt forgiven. The Mortgage Forgiveness Debt Relief Act does provide for sellers to not be taxed on the debt forgiven, there are certain qualifications which must be met. The first is that the home must be the debtors primary residence. This means a seller can't short sale a rental property and claim the forgiveness. Second, the debt forgiven must be from purchase money or a non cash out refinance. In other words, if you took out an equity loan to buy a boat or pay of credit card debt, you will be taxed on the amount forgiven.

Come back in 2 weeks for part 3 of To Short or Not to Short.

Important legal disclaimer: I am a Realtor with a lot of knowledge and experience on my side. I am not a lawyer or an accountant. As such, for legal or tax advise you should consult a professional in that field. This article is a collection of my opinions and should not be considered legal or tax advice.