Mortgages

Foreclosure vs. Short Sale: What’s Worse for Your Credit?

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Short sales are on the rise and more and more underwater homeowners asking how their credit scores will fare after a short sale or foreclosure – and how the two outcomes compare.  It’s a good question, since the homeowner will have to live with the consequences of this decision for at least seven years, the length of time “derogatory” information remains on a credit report.

Whereas you can expect a loan in foreclosure to appear on your credit report as a “foreclosure,” there is no such single, universally accepted description for short sale on credit reports, such as, well, “short sale.”  Instead, a loan paid via short sale tends to be labeled as either “charge off,” “deed-in-lieu of foreclosure,” or “settled for less than the full amount due” – all having about the same negative impact on your score as a foreclosure.

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Does this mean then that a foreclosed mortgage loan appearing on your credit report will always have about the same impact to your score as a short sale?  As with many credit scoring issues, the answer is both yes and no, depending on other information being reported about the loan – in this case, the balance and the past due amount. Generally, the higher these dollar amounts, the lower the score. (Read “What’s A Credit Score? Really?” if you’re looking for a clear explanation of credit scores.)

To dig a little deeper into the specifics, when a foreclosure is reported by a lender to the CRA (credit reporting agency), the balance appearing on the credit report for that item consists of the entire unpaid loan amount as of the date it went to foreclosure.  For a short sale, the reported balance is made up of the outstanding loan amount as of the date of the short sale, less the sale amount received from the buyer and agreed to by the lender.  If the difference between the reported balances under each of these two scenarios is substantial — and it should be — the negative impact to the score will be less for a short sale than a foreclosure.Free Credit Check & Monitoring

Past due amounts reported for a mortgage loan will impact the score similarly, as a higher past due amount leads to a lower score.  Typically, when a loan in foreclosure appears on a credit report, the entire outstanding balance also appears as the past due amount.  For a short sale, there should not be any past due amount reported — another plus on the short sale side of the equation.

[Related Article: Underwater on Your Home? Your Six Options]

But before future short sale sellers get too excited about this seemingly good news, they should also understand that any scoring benefits resulting from a short sale/foreclosure comparison are not likely to be either significant or long lasting. Such advantages tend to dissipate within a short period of time, as other, more recently reported information begins to have more of an impact on the score.

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Nor is it a good idea to base a short sale vs. foreclosure decision strictly on the anticipated impact to a credit score, when other factors, such as the ability to qualify for a mortgage in the future, are likely to affect your finances and general wellbeing long after your credit score has begun to recover.

Image: shouldbecleaning, via Flickr

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  • Pingback: Why are Short Sales So Bad for Your Credit? | ComparePlastic

  • Jackie

    Fascinating how nearly all agents market the impact of a short sale as non existent. However fico suggests the opposite (exactly the same hit like a foreclosure).
    Heres a good credit impact breakdown on this site http://practicallist.com/real-estate-short-sale along with fico as well as fannie mae data.

  • http://yahoo Lewis

    Well me and my husband are haveing a hard time in finding a place to live due to a forclosure and I understands it stays on for seven years but the thing about it is that we had a an offer for a short sale but the bank denied the offer . So what do you do in a case like ours. I no neither is good but at least we were making an effort to have someone purchase the house some people just walk away. Any suggestions.

    • http://forum.credit.com/ Barry Paperno

      Thanks for your comment. I agree there should be some benefit to you for trying to arrange a sale vs. walking away from the home. But unfortunately, the only real advantage to a short sale, other than possibly a little less of a score impact, is that a short sale won’t prevent you from obtaining a new mortgage during the next few years like a foreclosure will.

      Either way, you can rebuild your credit score long before the foreclosure falls off in 7 years if you keep all of your other credit accounts current, keep credit card balances low (below 25% if possible), and only open new accounts as necessary. Opening a new secured credit card or two is okay if you don’t have any other cards, as that will help you rebuild a positive credit history.

      Hopefully you’ll find an understanding landlord who will see the positive side of your credit experiences, which may be that you’ve handled credit for a number of years, paid loans as agreed, etc. Good luck!

  • John Murray

    Thank you for this timely article. I will surely bookmark it. Thank you

  • Pingback: What to Do If Foreclosure is Killing Your Credit » AtHomeSense.com AtHomeSense.com

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