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Borrowers wonder: foreclosure, deed in lieu or short sale?

In this struggling economy, many people cannot make mortgage payments and know they cannot afford to keep their house. When considering the different ways to forfeit their home, they may wonder, "What's worse: a foreclosure, a deed in lieu or a short sale?"

Many think that foreclosure is a last resort, due to its bad reputation and negative outcomes. That is not necessarily the case, especially when considering credit scores. The other options, deed in lieu and short sale, are different, but fairly similar. A short sale lets the borrower sell the house for less than the debt. A deed in lieu of foreclosure gives the home to the lender in exchange for cancellation of the loan.

According to Fair Isaac Corp., the company responsible for the FICO credit scoring model, foreclosure, deed in lieu and short sale are all forms of loan default, each having negative impacts on future credit scores. Each is predictive of future credit risk, and it will take time to rebuild credit. The important factor may not be the type of loan default chosen, but the original credit score.

Fair Isaac Corp. ran some numbers and showed that the higher the original credit score was, the harder it was hit and longer the recovery time. The FICO credit score scale goes from 300 to 850.

For example, a 780 credit score could drop 105 to 125 points after a short sale. It could take seven years to recover the original credit score. Someone starting with a credit score of 680 might see a 50- to 70-point drop, and credit score recovery might only take three years.

Even though the numbers between foreclosure, deed in lieu and short sale are not significantly different, certain lenders may view different types of loan default in different ways. However, when it comes to a credit score, they all have similar effects.

Source: The Washington Post, "What's worse for credit score - foreclosure, short sale or deed in lieu?" Michelle Singletary, 30 Aug. 2011

1 Comment

Well, not exactly everything. If you're forced into a short sale, you'll still get a 1009C from your lender, and you'll still have to file that with your taxes. Now, however, you're allowed to exclude the forgiven amount up to $2 million ($1 million if you're married, filing separately) from your taxable income. In other words, while it's still counted as income, you won't have to pay taxes on that amount of your income.

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