Homeowners who have the option of completing a short sale in order to avoid foreclosure may be better served by saving their home in this manner. Although there are a few drawbacks of a short sale, it is almost always better just to resolve the mortgage entirely and move on with fewer financial worries.



First of all, when homeowners complete the short sale, they will not have to pay the difference between what they owed originally and what the bank accepts. This counts as forgiven debt and is the main reason for doing the short sale. When property values decline, selling at a high price is almost impossible, and families in foreclosure have no other option for selling their home than to convince the bank to accept less.





However, borrowers may have to pay taxes on the difference, because the IRS treats any forgiven debt as income. But this does not count if the amount forgiven is higher than the market value of the home (when the property is underwater). If a family owes $125,000, but the bank accepts $100,000, and the home is now only worth $100,000, the borrowers will not have to pay taxes on the $25,000 forgiven debt.



The special tax form homeowners will receive from the bank at the end of the year is a 1099, which will list how much income the banks counts that the foreclosure victims received from the short sale and forgiven debt. To determine how to report this to the government, homeowners should talk to their tax preparer about how to count it in income, or read the IRS website for more information on how to treat it.



Another benefit of a short sale is that homeowners can not be sued or have wages garnished by using this method to stop foreclosure. The bank forgives the debt, meaning it is agreeing to release the lien on the house for less than the total amount owed. So the lender is unable from that point to sue the clients for a deficiency on a debt that the bank itself accepted and agreed to a deficiency on.



However, if the property went through a normal foreclosure, the bank may be able to sue the borrowers again after the sheriff sale, depending on the circumstances and the state foreclosure laws. Almost no banks, though, do this, as they figure there is little chance they will be able to collect on any future deficiency judgment against foreclosure victims.



Nor can the bank, as a result of the short sale, put a lien on any other home the borrowers might own. Any part of the debt that is forgiven is no longer owed to the bank -- it accepts the lower amount in return for releasing the lien and not pursuing foreclosure. So homeowners do not even owe the mortgage company any more money once the bank accepts the short sale.



Although banks may not be willing to work enthusiastically with homeowners during a short sale process, persistence pays off. This option will allow more people to escape from a house without the threat of a foreclosure on their credit or the fear of the bank hounding them for a deficiency judgment for years to come. If saving the home some other way is not an option, and market values have declined to make selling difficult, a short sale may be a good compromise for borrowers and lenders.