Mortgages

Credit Q&A: Short Sales, Foreclosures and Your Credit Score

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Question: The value of my home has gone way down and is now worth less than what I owe.  A friend is recommending I do a short sale saying it won’t hurt my credit score as much as a foreclosure.  Is that true?

It’s not surprising this question comes up quite often considering that over 11 million households (23 percent of all mortgaged homes), were underwater in the Oct-Dec 2010 quarter according to a report released by Corelogic. With so many consumers evaluating their options, it’s important to understand the difference between a short sale and a foreclosure, and how each option may impact your credit scores.

So, what’s the difference between a short sale and a foreclosure? Simply put, a short sale occurs when the lender agrees to accept less than the total amount owed on the mortgage loan. A foreclosure on the other hand, is the legal termination of all rights of the borrower as the owner of the home and the lender in essence repossesses the home. In a foreclosure, the estate becomes the absolute property of the lending institution.

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The presence of either a foreclosure or short sale on a credit report is considered negative by credit scores because it is predictive of future credit risk. Generally speaking, the impact on the score will be similar for both a foreclosure and a short sale.

The exact score impact of a foreclosure or a short sale will depend on several factors:

  • Any additional information being reported on the mortgage account being included in a foreclosure or short sale. (For example, any late payments associated with said mortgage account prior to the foreclosure or short sale and how recently those past due payments took place.)
  • The current credit profile of the consumer.  How the consumer is managing all their other credit obligations (credit cards, car loans, student loan, etc.).  Are these other bills being paid on time or have missed payment been reported on these as well? Are credit cards showing high balances?

The negative impact on a credit score appears more severe if a foreclosure or short sale is reported on a credit report that has little or no history of missed payments and/or derogatory information, and has low balances on active credit accounts.  In these scenarios, the number of points lost can be 150 or greater. The impact may be less noticeable if there are any indications of high-risk behavior (missed payments, etc.) already being reported in the credit report. This is because the negative history is already impacting the credit score which will be lower as a result, reflecting that higher risk behavior.

[Related: Prioritizing Financial Literacy in 2011]

The perception that a short sale will always have less impact on a credit score compared to a foreclosure is simply a credit score myth.  Bottom line, the score considers both items to be negative, high-risk behaviors, so both options will have a negative impact on the score.

Have a credit related question for Tom?  Post your questions in the comments below!

Image by Mike Licht, via Flickr

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

  • http://preventingforeclosure.org Preventing Foreclosure

    Though the credit score drop may be the same for both foreclosures and short sales, and I might argue against both of them having the same effect on your credit score, there is one definite difference. If the homeowner is planning on purchasing a new home in the near term after losing the current home, Fannie Mae looks more favorably on having a short sale on your credit report compared to a foreclosure: http://preventingforeclosure.org/news/tax-credit-consequences-of-a-short-sale/

    In addition, there are tax consequences that need to be considered when comparing a short sale and foreclosure. These issues are discussed as well at the link above.

  • Troy Funk

    Tom, great Information — This question consistently comes up, “What is the impact of a Short Sale or Foreclosure on my Credit”, from consumers contacting me on my blog; http://www.SarasotaShortSaleBlog.com. As you pointed out, there are many factors beyond just the Short Sale or Foreclosure that will determine how fast a consumer can restore their credit. Besides the time it takes to restore credit, another advantage a consumer has to completing a Short Sale vs. Foreclosure is the ability to potentially eliminate the risk of a deficiency judgment. I am big believer that Short Sale is worth the effort, compared to doing nothing and walking away (foreclosure)

  • Pingback: How A Short Sale Or Foreclosure Will Impact Your Credit Score | Wordwide News Exposed

  • Sarah

    I have friends who opted for a short sale, versus a foreclosure, because their realtor encouraged it. In fact, the realtor personally gained several thousand dollars in the transaction. The bank holding the original loan sold the loan to an investor, who is now holding onto my friend’s 1099 forms (keeping this file open). In addition, the investor can come after my friends at any point to collect the difference between the original loan amount and the short sale amount. In further addition, since my friends had borrowed against their equity to make home improvements (new windows, etc), they must now (4years later) produce receipts proving all of the money went back into the house. Any remaining money will be taxed 30%!
    How common is this scenario?

    • http://www.valoansdoneright.com VA Loans Done Right

      Sarah,

      In addition to what’s already been said, I’m going to suggest that your friend look up the statute of limitations (SOL) for their state. The SOL is the amount of time the creditor has to pursue legal remedy.

  • Sedona Homes

    Sarah,
    The Mortgage Debt Relief Act of 2007 excludes them from having to pay taxes on the “income” if it is the principal residence. It expires in 2012. This is Federal, the individual States may handle it differently. Also realize that the ability of a bank or note holder to come after someone for the remainder of the debt varies by State. In Arizona, they can’t do it on a principal residence mortgage, in VA they can. I’d suggest negotiating with the note holder over a lot of these items and not leave it to chance.

    Google the Act and you’ll find plenty of information on it.

  • Pingback: More Consumers Turn to Short Sales on Underwater Homes | There is Life After Foreclosure. Are You Preserving Your Financial Future?

  • Matt

    I currently just settled a short sale and found out recently that the short sale was reported as a foreclosure on my credit. Is a short sale reported as a foreclosure and if not can you suggest where I might start in cleaning up the credit mess that this foreclosure reporting is causing.

  • http://www.valoansdoneright.com VA Loans Done Right

    @ Matt,

    I have a client that I’m working with right now who is in the same boat. They did a short sale but on their credit it has a reporting code (M9) indicating a foreclosure. This is the way the bureaus (Transunion, Equifax and Experian) report it not the original creditor.

    • hsosaus

      Hi VA Loans Done RIght,
      I am in the same scenario as your client. I short sold my home in June 2010 and I am now looking to buy again. But was told that I can’t because of the M-9 reporting by the agencies. Citimortgage told me that they will contact the credit bureaus to help resolve and gave me a case number with their credit bureau dispute department. What else should I be doing to help correct and take out the M-9 rating? How long does this usuallly take for it to all clear up and be corrected?

  • http://www.foreclosure-information.org/ free foreclosure information

    Consumers have known that short sales, foreclosures and bankruptcies can have significant negative impacts on their credit reports and credit scores. A new report was recently released that details how much your credit score will be affected by a number of negative financial situations.

  • April

    2 years ago we did a short sale on a home in Arizona. We did it because of a company transfer and the home value had dropped 15% when we moved. We held onto the house for nearly a year after we moved to try to “wait it out” and we had purchased another home in the meantime. We never stopped paying on the mortgage until it was sold, so therefore were never delinquent. It didn’t seem to affect my credit score, however we recently moved again and have found out that the bank had listed us as delinquent on the loan and therefore we cannot qualify for a mortgage for 3 years post the last reporting. I make 6 figures+ a year, have over 700 credit score and have cash for down payment, but can’t get a mortgage. Any advice on how we might be able to get this fixed?

    • http://www.valoansdoneright.com VA Loans Done Right

      Hi April,
      You may have a couple of options.
      1) Dispute the late payment on your credit
      2) If you have 20% for a down payment you can go with a Fannie Mae or Freddie Mac loan once you hit 2 years from the date of the short sale.
      One thing to look at is how late your previous bank reported you. If they have you down as 120 days late you’re going to be held to the same underwriting guidelines as someone who went through a foreclosure. FHA guidelines require 3 years, the no money down USDA loan requires the same, VA requires 2 years.

  • Pingback: Learning How Short Sales & Foreclosures Affect Credit Score | Antonio Reese, Reese Realty Group

  • sea

    hello, i apologize if this question has been answered already. I did a recent check on my credit report and see that my previous lender listed our short sale as a foreclosure on the report. i understand the credit drop may be the same but should it say short sale? i feel like if it did then future lenders will see that we tried to settle rather than just walked away.

  • Pingback: Short sale impact to your credit score

  • robert james

    How much does a short sale affect my credit if I already amodified my loan and my credit is bad? I actually have an oppurtunity for an “equity sale” but I might have to pay $2,000.00 to make up the difference because its all the buyer could do or all my realtor wanted to do so he could get paid faster than going through a short sale. My credit score is already pretty bad – 580. I almost feel like just going through the short sale just to save a couple grand because this “equity sale” after modifying my loan is going to cost me $90,000 of down payment anyway.

    • http://www.credit.com/ Credit.com Credit Experts

      Robert – Based on what you’ve explained here, you’re better off opting for the short sale “now” as opposed to waiting because you’ll get all the damage over with so that you can focus on your improvement efforts after the fact. You see, as far as credit scores are concerned, there is no difference between a short sale and a foreclosure — both are very damaging. However, because your scores are already taking a beating (580), it would be better to take the hit now — rather than trying to improve your scores over the next 12-24 months, and THEN short selling. If you go this route, your improvement efforts will be for naught because when the short sale is reported, your credit will be negatively impacted and it will undo all the work you would have been focusing on otherwise. For more on short sales, their impact on your credit, and how to recover from the damage, the following resources should help:

      Why are Short Sales So Bad for Your Credit?
      How Soon Can I Get a Mortgage After Credit Problems?
      How to Rebuild Your Credit
      The Ultimate Guide to Credit Scores

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