Short Sale and Credit: What's the Impact?

For many homeowners who are forced to sell their homes or for homeowners who see trouble ahead, a short sale is a last resort. Because short sale credit effects are lasting and the bank will take a loss, a short sale is not an easy way out for the homeowner or the bank, but it can help prevent foreclosure. Foreclosure would result in a total loss for the homeowner and devastating effects on credit, and a partial loss for the bank.

A short sale is a process that allows the homeowner to sell the home and settle the mortgage debt for less than the amount owed on the home. If a bank or homeowner sees no other solution, a short sale may be agreed upon by both parties involved. However, it is ultimately up to the bank as to whether or not it will accept this type of sale rather than foreclose on the home. Because a financial institution is a business first, it will weigh the financial pros and cons before it will allow a short sale. In some states, a foreclosure costs less than a short sale, from filing through the end of the process. In others, banks might make anywhere from 20-30 percent more on a short sale. Even if a bank decides that it might make more on a short sale, there are still a number of requirements homeowners must meet: In order to qualify for a short sale, you must:

• be unable to afford your current monthly mortgage payment
• be unable to modify your current home loan
• have a hardship, such as a job loss, divorce or medical emergency
• owe more than your house is worth

Once it has been determined that a homeowner qualifies for a short sale, and the bank feels it will make more of a profit by allowing a short sale, the homeowner must consider short sale credit effects – both short and long-term.

Homeowners in trouble often ask the question 'will my credit be hurt by a short sale?' The short answer is yes. A short sale will have a negative effect on your credit in several ways. For starters, the bank will report the short sale to the three major credit reporting bureaus as “paid in full for less than the full balance.” To potential creditors, this means that a portion of the balance was written off and the bank took a loss. Strike one.

The next issue is your FICO score. Because a short sale is viewed as a blemish on your credit report, your FICO score will drop. Strike two. If your score drops below 620, you will have a difficult time securing another loan. In addition, even if your score is above 620, some banks require a two year waiting period before you can apply for a new home loan after a short sale compared to five to seven years after a foreclosure.

One of the most complicated issues regarding short sales and your credit is the balance that the bank “wrote off.” Where does the written off portion go? Unfortunately, the bank can still hand this amount over to a collection agency. The collection agency will attempt to collect the amount that has been written off. If you do not pay the collection agency, it will report it to the three major credit agencies where it will remain for up to seven years. Even if you begin making payments to the collection agency, the most it will do is report the payments to the three major credit bureaus on a regular basis. This will at least show that you are making timely payments.

In the end, a short sale should be used as a last resort. Recent figures show that most sellers have not utilized this option. According to the National Association of Realtors, only 12 percent of home sales in the U.S. from April 2009 to April 2010 were short sales.

Bank of America

National Association of Realtors

Understanding Credit Scores, MyFico.com