Short sales are all the rage in the real estate world.  I am sure that if you own a home, you have at the very least considered it as an option. This is especially true if you bought your house at any time during the last bubble and now find yourself under water.  In case you know the term but not the meaning, a short sale is when you sell your home for less than your mortgage balance and get the bank or mortgage lender to agree to accept the reduced amount in lieu of foreclosure.  Realtors and lenders are telling people that the credit damage done by a short sale is better than a foreclosure and that it is more honorable.  Like most things in life, you shouldn't necessarily believe everything that you are told!

First of all, before short selling (as opposed to allowing a foreclosure to take place) you need to check with your state laws regarding deficiency claims.  This is why there are real estate lawyers.  Never sign a contract and agree to it, in this or anything else of significance, without seeking counsel.  No matter how smart you are, if you have yourself for a lawyer you have a fool for a client.  He/she will advise you regarding state laws.  For example, in my home state of Arizona, if you are foreclosed upon and there is a deficiency, it is immaterial and you are off the hook for the debt.  On the other hand, lenders are writing into their agreements these often sneaky little clauses that say, in effect, that while they have no intention of pursuing the borrower for the deficiency at the present time, they reserve the right to do so down the road.

Realtors, eager to collect commission, tell sellers of short sales not to worry about that. They assure the seller that the lenders have no intention of suing down the road, as there are just too many of these to handle plus they hit the "hot button" of doing the right thing as opposed to a foreclosure which is evidently the "wrong thing". 

Look gang, if down the road things get better and stabilize I can almost guarantee that some enterprising young corporate lawyer for the lender is likely going to recommend to management that they begin pursuing lawsuits to collect shortages - if for no other reason than it will be a new cash cow for the company.  If they have desire to ever sue - let them put it in the contract otherwise, don't believe your realtor!

The point I want to make here, is that it may be a lot smarter to go with foreclosure.  The credit scar is bad either way, so why worry about it when there are other financial and legal considerations?  To my school of thought, it is all about being smart and not worrying about what other people may think about you, as I always say, they aren't thinking about you at all.  They are thinking about themselves, just like everyone else.  Look out for yourself and be smart.