Which is better for a homeowner in financial distress--a foreclosure or short sale? For the majority of debtors, a short sale is preferable.
Both Hurt Your Credit
Start by taking one concern off the table: since your credit is going to be hurt either way, the impact on your credit score should not be a driving factor in your decision. While a short sale is voluntary and a foreclosure (generally) involuntary, both represent a failure to pay a debt in full, and both have similar impacts on your credit score. Because the credit-reporting agencies keep their scoring formulas close to their vests, it's impossible to know the exact impact, but most observers feel that for someone who'd previously had good credit, a foreclosure or a short sale could reduce the credit score by up to 200 points.
Short Sale Eliminates Any Further Obligations to Pay
Technically, anyone can sell a house for less than the remaining mortgage at any time, and that would be a "short sale." However, as the term is commonly used, a short sale is a bank-approved sale for less than the remaining mortgage. The bank approval is key: if the bank agrees to accept less than the remaining mortgage balance as payment in full, the homeowner is off the hook once she closes the sale. A short sale made with lender agreement will result in losing the home but otherwise getting a fresh start, without the burden of additional mortgage debt.
Foreclosure Doesn't Wipe Out Mortgage Debt
When a home is foreclosed, the lender exercises its right to repossess the home. (That's what foreclosure is--repossession.) It will take possession of the home and sell it. Whatever proceeds it receives are applied against what the homeowner owes. Since the home is almost certainly worth less than the balance owed under the mortgage--if it wasn't, the homeowner presumably would have sold it herself--foreclosure will leave the homeowner owing money.
Unfortunately, in many states, the bank has the right to go after the homeowner for the deficiency. (Some states bar what is called a "deficiency judgment.") In those states, the bank could sue the defaulting homeowner for the remaining money owed under the mortgage.
When to Talk to a Foreclosure Lawyer
An attorney can help a distressed homewner determine the best option--for example, in states that do not allow deficiency judgments, letting the home go into foreclosure may be a viable choice. The attorney can also help a homeowner looking to make a short sale negotiate with the bank and navigate through the paperwork.
