How Will A Short Sale Affect My Credit Score?

by Kevin Mulligan

The lead up to the Great Recession was fueled by cheap credit, improper lending practices, and the unrealistic belief that housing prices could only go up. While some communities have seen housing price recoveries back to somewhat normal levels, others are still suffocating on a market full of foreclosures.

All of the negative housing trends have hurt even the most honest of homeowners; those that provided a 20% down payment and didn’t buy more house than they could afford are getting burned by the housing bubble. With markets full of foreclosures and short sales, if you own a home that is now underwater and find yourself needing to move you may be forced to accept a short sale.

One of the most common questions from those with underwater mortgages is deciding whether to rent out their home, try to do a short sale, or to let the home fall into foreclosure. Today let’s talk about how long a short sale can impact your credit score.

Credit Score Damage from Short Sales

Short sales can have significant impact on your credit score.

Short sales can have significant impact on your credit score.

A short sale is where you sell your home to a third party for less than what you owe on the mortgage. The financial institution holding your mortgage must agree to the short sale first because they are writing off the difference between what you owe on the mortgage and the proceeds from the short sale.

Whether you are current on your mortgage when you do a short sale or if you haven’t been able to make your payments for a few months, the lender is not going to be happy. (Rightfully so!) You have an agreement to repay a certain amount of money and you are unable to do so. Just as would happen with any other type of loan that you can’t repay, the lender will report the short sale as a default to your credit report.

This short sale default on your credit report will cause both immediate and long term damage to your credit score.

How Long Does a Short Sale Impact Credit Scores?

The Fair Isaac Corporation that invented FICO scores (the most commonly used credit scoring system) has a set of tables that outline the damage to your score from various types of loan delinquencies.

Immediate Credit Score Damage from a Short Sale

Most people that end up with a short sale don’t go from being on time with all of their payments to a short sale overnight. (Most lenders won’t even consider a short sale until you miss several mortgage payments.) The damage happens as time goes on and the late payments add up.

Being 30 days late on your mortgage dings you anywhere from 60 to 110 points. That’s enough to take you from an excellent credit score of 760 down to a mediocre score of 650. Then at 90 days past due you may take another hit based on your starting score and how far things have fallen.

The best way to minimize the damage to your score is to try and stay current or just a little late on your payments before your short sale. Otherwise the late and missed payments will stay on your credit report as well.

Long Term Credit Score Damage from a Short Sale

While the immediate impact is painful, the worst is yet to come for your credit score.

There is a myth in personal finance that a foreclosure is significantly worse than a short sale when it comes to your credit score. Unfortunately, this is simply not true.

A foreclosure is a default on a loan agreement. A short sale is a default on a loan agreement. Both will show up on your credit report as a default on a loan agreement.

That means you can expect to see the short sale on your credit report for seven years before it falls off. That doesn’t mean you won’t be able to purchase a home during that entire seven years, but you can easily expect delays of two to five years before a lender will touch you. (And the shorter the time period since your short sale, the better your financial documentation and overall financial situation needs to be.)

Your credit score will drop to the upper 500s to maybe low 600s once the short sale hits your credit report. Aside from not being able to purchase a home you will also have higher interest rates for other types of loans – if you are able to secure them.

Final Thoughts on Short Sales

Sometimes a short sale is inevitable. Maybe you purchased more home than you could afford, or maybe your area just got hit by the housing bust harder than other areas. Honest homeowners and people who intentionally overextended themselves have all been caught up with short sales and foreclosures.

Taking a short sale on your home may be inevitable, and the credit score damage will be severe. However, it isn’t the end of the world and after seven years your report won’t have any comment of the delinquency.

Have you been through a short sale? What other comments and suggestions can you provide for the readers? Leave a comment!

Photo Credit: i am real estate photographer

Published or updated April 4, 2013.
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