As we continue to wade through the aftermath of the real estate meltdown, many people feel they’ve reached the end of the rope with their property and are considering things they never thought they would, like short sales or even foreclosure. In some cases, there are simply no other options left. However, if you are still somewhere in the grey area, please consider the effect that such drastic measures can have on your personal credit.
What is a Short Sale?
In terms of real estate, a short sale is when you sell your property for less than you owe, thereby only partially paying back the bank. The amount that you’re short on your obligation is called a deficiency; depending on your agreement with the bank, you may or may not still have to pay back the deficiency. In addition, the IRS could potentially consider debt forgiveness as income (if not covered by the Mortgage Debt Relief Act of 2007.) It is important to note that not all lenders will accept a short sale, and not all sellers or properties will qualify. The reason some banks accept short sales is that it costs them much less money than it would to foreclose on the property.
Effect on Your Credit
Many people mistakenly believe that a short sale will have a less derogatory effect on their credit than a foreclosure. The bottom line is that both situations effectively mean that one was not able to fulfill their debt obligation and did not meet the terms of their loan contract as agreed. According to FICO, either a foreclosure or a short sale can lower your score significantly. The actual amount of points depends primarily on your current credit score, the degree of your payment delinquency; if you have multiple consecutive months of nonpayment, the damage will be significantly worse. (Just a 30-day mortgage late pay alone can lower your score by up to 100 points!!)
If you have executed a short sale, it could show up on your credit report in a variety of ways, depending on your lender and your specific circumstances. Most of the time, a short sale will show up as “settled as agreed” or “account legally paid in full for less than the full balance.” If your mortgage is more than 120 days delinquent, it could even show up as a “foreclosure” even if a foreclosure has not truly been initiated. Any of these on your report is categorized by FICO as a “serious delinquency.”
Benefits of a Short Sale vs. Foreclosure
While neither scenario is ideal, there are some factors that may make a short sale slightly more appealing than a foreclosure:
- While the effect on your score is the same, a short sale generally takes less time to complete than a foreclosure, so your score could potentially get on the road to recovery more quickly.
- Fannie Mae prohibits loans after a foreclosure for seven years vs. just two years with a short sale, so you could potentially qualify for a future loan more quickly.
- You are in control of the sale of your home instead of the bank.
- In some situations, you can initiate a short sale without first being delinquent on your payments.
The above points notwithstanding, a short sale should still be considered a LAST RESORT option. Further, you should always discuss your situation with a financial professional before making what will be a very impactful decision. Take a look at this article: Mortgage Modification Options: HAMP vs HARP vs HAFA (Avoid Foreclosure!) to help decide which road is the best for your situation.