Many thanks for all of the thoughtful answers. Your input is much appreciated.

There are two entirely different issues involved here. Let's separate them.

The first is the impact that a foreclosure will have versus a short sale. The other answers here are correct. A short sale usually is less harmful, often far less harmful. So, Azre, it's your responsibility to know and understand that. Obviously, not to provide legal or accounting advice, but to be aware of the implications of each. And there's plenty of information out there on that.

You ask: "Also, how many points are deducted for short sale vs foreclosure on a credit score? Why does no one know this, or won't say?" Jim's answer is on that point is very good. Look: No one knows exactly because the credit reporting agencies keep their formulas secret. And it's very likely that the actual impact is influenced by multiple factors, not just a yes/no foreclosure/shortsale.

So, point one: Good information is out there. It's your obligation to know it, just as it's your obligation to refer an owner to a lawyer or an accountant when appropriate.

Point Two: You ask whether it's ethical to advise walking away. And here I disagree slightly with some of the advice below. I agree totally that legal advice should be given by laweyers, not Realtors. I agree totally that accounting or tax advice should be given by accountants, not Realtors. But Realtors do have ethical responsibilities. And within our field of knowledge, we not only can but must act ethically and provide advice on that basis. Here on Trulia and elsewhere I've offered my opinion numerous times when people have asked: "I'm upside down on my property. I can afford the payments, but I hate it that I owe $100,000 more than the property is worth. I'd just like to buy another property. Then, when that's done, I'll give this one back to the bank." And I've responded that ethically that's wrong. At least with my code of ethics. Just because other people are doing it doesn't mean it's right.

And, frankly, I can imagine some scenarios in which, ethically, it would be better to "walk away" than attempt a short sale. Not many, but some.

As noted above, though, your question regarding ethics appears to be based on the incorrect belief that a short sale has worse implications for the seller than a foreclosure.

Further, ethical choices are often just that--choices. On one hand may be the financial implications. On the other hand may be familial obligations, or other issues that balance off the financial implications. So even after getting the facts on short sales versus foreclosures, there's a lot more to providing advice than the raw numbers.

Hello Azre.

Why would a lender pursue a borrower AFTER a short sale has successfully closed when the lender has released the lien AND they know that the borrower is protected by the AZ anti-deficiency statutes? I have not heard of one case of this happening, although I'm not saying that it hasn't happened. I've just never heard of it occuring. Typically, the lender tries to negotiate this into the short payoff (approval letter) BEFORE there is short sale approval. The agent (or attorney) negotiating the short sale needs to be a shrewd negotiator and have signficant knowledge of the law in order to avoid this happening.

I would be interested in seeing if there are any agents out there (or short-sellers) that have been contacted by their previous lender(s) AFTER a successful short sale has closed and the lien released, and asked to pay back some of the deficiency. I'm not saying it isn't possible, just not likely.
*This is a great question for a real estate attorney, one who specializes in foreclosures.

To answer your question: "Also, the difference will not be considered income and taxed accordingly? I know legislation is in place to protect foreclosed borrowers, but is that true for a short sale?"

Check the IRS website, the Mortgage Debt Relief Act:
http://www.irs.gov/individuals/article/0,,id=179414,00.html

This is taken directly from the IRS site:
"If I sold my home at a loss and the remaining loan is forgiven, does this constitute a cancellation of debt?"
"Yes. To the extent that a loan from a lender is not fully satisfied and a lender cancels the unsatisfied debt, you have cancellation of indebtedness income. If the amount forgiven or canceled is $600 or more, the lender must generally issue Form 1099-C, Cancellation of Debt, showing the amount of debt canceled. However, you may be able to exclude part or all of this income if the debt was qualified principal residence indebtedness, you were insolvent immediately before the discharge, or if the debt was canceled in a title 11 bankruptcy case. An exclusion is also available for the cancellation of certain nonbusiness debts of a qualified individual as a result of a disaster in a Midwestern disaster area. See Form 982 for details."

To sell your home at a loss is another name for a 'short-sale'. So, you can clearly see that it WILL qualify for this 'cancellation' of debt per the IRS guidelines. Of course, there are other questions that need to be asked...is the loan securing the home a 'RE-FI'? Then it could be treated differently in regards to the cancellation of debt provision...see the link above for further explanation. That being said, the proper steps need to be taken to make sure it's filed properly come tax time.

Regarding the credit score implications, I recently attended a one-day conference by Marianne Kingman, of Kingman & Winslow. She is VERY knowledgable in foreclosure tax implications, see her profile here:
http://www.kingmanwinslow.com/readbio.asp?bioname=mkingman

Her firm will give a free 30 minute consult to anyone considering a short sale. I would recommend this for EVERYONE considering a short sale.

According to the information she gave us that day, the credit hit varies from bureau to bureau, but it can be 100-150 for a short sale, and 200+ for a foreclosure. The real difference is when you go to apply for a future loan. A foreclosure is likely to stay on your credit for up to 7 years. A short sale is typically 2-4 years.

Marianne and her colleague also stated that the lenders have a contract with the IRS that states that they are required to file a 1099 with the Feds EVERY time there is a cancellation of debt, be it a short sale or a foreclosure. HOWEVER, some lenders choose NOT to file the 1099, and simply pay a penalty to the IRS for non-filing. She stated to us...it's NOT a LAW, simply a CONTRACT that is in place, and if the lender chooses to 'breach' the contract, which they can, they'll pay a fine. Is it possible to predict or guess which lenders do and do not file their 1099's? I surely wouldn't even begin to touch that one. I find it best to say that it will be filed EVERY time, in which case the borrower should see some tax advice from a qualified tax attorney or CPA when they're ready to file their personal taxes.

It just seems to me that with the thousands of short sales going on in our state, and the hundreds of thousands in process in the US, that it is a viable option to foreclosure and one that should be considered any time a borrower is in default on their mortgage. With the proper guidance and advice (and disclosure), it can be as painless as a regular sale.

Jim Mitchell
Century 21 All Star, REALTORS

So we're taking it as a given that every lender will consider the completed short sale to be the end of it and will not pursue the seller for the difference? My understanding is that they could, whereas AZ statute stipulates no recourse on a default.

Also, the difference will not be considered income and taxed accordingly? I know legislation is in place to protect foreclosed borrowers, but is that true for a short sale?

Also, how many points are deducted for short sale vs foreclosure on a credit score? Why does no one know this, or won't say? I heard one banker at a CE class divulge that, essentially, it's just as bad as a foreclosure on the credit score. What exactly does "not as bad" mean? 10 points? 300 points?

Obviously lawyers and tax experts will be recommended. It just doesn't help realtors' tarnished reputations to recommend people go through a lengthy, emotional process unless it really does help them

I'm with Jim (and Susan and Randy). I don't understand, at all, why a short sale is "so much more punitive" than walking away.

But the bottom line is, fiduciary duty or not, it is not an agent's place to suggest walking away from a legal financial obligation. They need to consult with legal and financial experts, neither of which an agent is (unless you're an attorney and CPA as well). That's the advice you should be giving your client.

Great answer Susan. I think a lot of agents are falling into thinking they should provide legal advise regarding options for homeowners in trouble. This is the job of an attorney who specializes in foreclosures, short sales and related matters, not a real estate agent.

Our job is to best represent the interests of our clients with regard to the buying and selling of real property, not advising them of the legal and tax consequestions of their options.

A Short Sale on a non recourse loan, will be settled in full so why is that worse than walking away?

That said a Real Estate Agent is NOT qualified to give legal advise, thus you should never advise your clients on what they should do in terms of letting the home go or short selling it. They should seek professional legal counsel and make their own decision thereafter

I'm with Susan on this one. We need WAY more details before commenting. Give us details, and maybe we can give you some valid input.

Hello Azre.

Define 'punitive'...

What's wrong with getting a 'full-lien release and satisfaction of mortgage', which is what you get most of the time when you short sell your home? That's an ideal situation and about as 'non-punitive' as you can get.

It's only when you start talking 'non-secured' promissory notes that the lender might require the borrower to sign that it becomes 'punitive', at least from a financial standpoint in that they'll be a bit lighter in the wallet.

I would also advise that you really look into the loan that is currently in place on the home. I realize AZ is non-recourse (at least for the time being), but:
>Was it 'purchase money'? 'Re-Fi'?
>Was it FHA, VA or Conventional?
>Is there a 'HELOC' or a true 2nd-mortgage in place?
>Is it 'owner-occupied' or a 2nd/investor home?

These are important questions to ask and could affect the borrower AFTER they 'walk-away' and let it foreclose.

When you consider that it shouldn't cost the borrower a dime to list and short-sell their home (with an experienced agent), and the fact that it's significantly less damaging to their credit, it doesn't make sense NOT to explore that option first and foremost before just 'walking away', like so many other people have done.

Agree or disagree?

Jim Mitchell
Century 21 All Star, REALTORS

Did their attorney advise them to walk away? If they don't have an attorney advising them, they certainly need one if they're seriously considering walking away from a financial obligation.

Are you not there to present them with options and not advise them?
Isn't it their decision as to what they choose to do based on the information they have received?

Why is the short sale option so much more punitive than walking away?

What did your broker advise you to do?

Susan Ellis
Mira Vista Properties