Short Sale vs. Foreclosure:

We’ve recently discussed home foreclosures and the various alternatives to “walking away” from one’s home, including short sales.  It seems reasonable to compare the short sales and foreclosures directly.  Which is the superior option for the homeowner who isn’t going to be able to make the required payments on his or hre property and for whom mortgage restructuring just isn’t possible>

Overall, short sales are a better option.

The Guiding Principle

The short sale vs. foreclosure controversy should be informed by one core principle:  A foreclosure is the option of last resort.  Everything, including a short sale, is preferable to a foreclosure.  As DebtKid.com explains:

The inevitable result of a foreclosure is the lender taking your house. Not only will you lose your house, but the lender can get a judgment against you for the arrearages you owe plus his costs for the foreclosure action. If that isn’t enough, your credit report will be in terminal condition for many years to come, worsening an already bad financial situation and making it very difficult to obtain any other kind of credit. There is no upside to foreclosure. It should be avoided at all costs.

So, the contest is easy to resolve.  In the war of short sale vs. foreclosure, the short sale wins.  The real qeustion is why and by how much.

The Credit Score Situation

Many people believe that pursuing and closing a short sale will be better for their credit score than a bankruptcy.  In fact, it’s not hard to find numerous people advocating the idea one can better protect his or her credit with a short sale.  While I do recommend shot selling over foreclosures, people should know that the credit score issue isn’t nearly as significant as some poeple make it out to be.

The Wall Street Journal recently ran an article that was based, in large measure, on a conversation with Craig Watts, a spokesperson for Fair Isaac==the very people behind the FICO credit score.  The article explains:

Although a short sale, where the lender agrees to take less than owed on the mortgage, will drop your FICO score as much as a foreclosure will, there is one advantage to it: You may be eligible to buy a home with an institutional loan backed by Fannie Mae or Freddie Mac more quickly than you would if it went into foreclosure.

[emphasis mine]

In other words, the actual damage to your credit score is about the same with either options. The aforementioned article does raise a real advantage to short-selling, though.

Buying Another Home

Those who short sell instead of allowing foreclosure usually do have the opportunity to purchase a different home earlier than those who go through bankruptcy.  That might not make much a difference in the short-term, but everyone’s financial situations have a tendency to change and they can sometimes change quickly.  You don’t want to miss an ideal property at a price you afford if you can avoid it.

Other Reasons to Prefer Short Sale

You may be able to negotiate your move date with a short sale, something you can’t always manage with a foreclosure.  You can honestly fill out loan applications stating that you sold your residence instead of admitting to a failure to meet the terms of your mortgage.  As alluded to in the earlier quotation from DebtKid.com, short sales also decrease the likelihood of being forced to confront arrearages and costs related to the foreclosure.

Overall, the short sale wins the short sale vs. foreclosure contest easily.  If you’re forced to choose between the two, pursue the short sale and don’t surrender in the face of foreclosure.