I’m in foreclosure. Should I just walk away?

Today, this decision is happening at all income levels with many homeowners deciding to simply walk away and let the bank foreclose, thinking that it’s the easier choice.

The truth is that unless you are planning on living in a cave in the future, you should try to avoid foreclosure at all costs to save what’s left of your credit. That said, often a short sale is your best and only option. Here’s why a short sale is better than a foreclosure.

First, let’s understand that foreclosure is the bank’s way of trying to satisfying their financial claim against a homeowner when they stop making payments. They have that claim because when the homeowner bought their house, they signed a mortgage to secure the loan. And the bank could seek a judgment against the homeowner after the foreclosure completes, for the balance of the mortgage owed.

A short sale is actually a process that allows the homeowner to sell the property with the bank’s approval, for less than what is owed to the bank, and stop the foreclosure process. After a short sale, depending on the financial situation of the owner, and their policies, the bank could seek a judgment against the owner for the balance. In addition, the IRS, could view the forgiven mortgage balance as phantom income.

So, if either the bank or the IRS could come after you for the balance, or the taxes, why does it matter? Why not just walk away and let the bank foreclose? Here are some considerations that should be part of this decision:

• With a foreclosure, your credit score may be lowered by 250 to 300 points. Typically they affect your score for over 3 years. In a short sale, the credit score is lowered by much less and the mortgage will be reported as paid or negotiated, while affecting your score for 12 to 18 months.
• A foreclosure remains on the credit history for 10 years or more. A short sale is not reported on a credit history. It is usually reported as “settled for less than the full amount”.
• A foreclosure takes much longer to process than does a short sale, resulting in a higher amount of the deficiency judgment for additional taxes, maintenance, and interest costs. A short sale will usually have a much smaller judgment associated with it.
• A homeowner who loses a home to foreclosure is ineligible for a Fannie Mae mortgage for five years. A short sale homeowner is eligible for a Fannie Mae backed mortgage after only two years.

No one wants to be in a situation to have to make this choice. But if forced to choose, the short sale route is truly the lesser of two evils.