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How To Understand The Impact Of A Short Sale On Your Credit Score


If you’re struggling to keep up with your house payments each month, it may be time to crawl out from under the burden of your mortgage. Unfortunately, if your property value has dropped, you may owe more on your home than it’s worth—leaving you unable to recoup enough money from the home’s sale to pay off your mortgage debt. If your bank approves a short sale, it will appraise the home and allow you to sell it for its fair market value, regardless of how much you owe. A short sale may help you avoid foreclosure, but it carries considerable consequences for your credit scores.

Short Sale vs. Foreclosure

The reason a foreclosure is so detrimental to your credit scores is because it indicates that you defaulted on a major debt. One of the biggest myths in the real estate industry is that a short sale isn’t as damaging to your credit scores as a foreclosure. A short sale, however, is just as much an indicator of default as a foreclosure. As a result, it can have the same negative impact on your credit rating.

One of the major differences between short sales and foreclosures is that lenders don’t always require homeowners to miss payments before approving a short sale. The missed payments leading up to a mortgage default are just as damaging as the default itself—sometimes more so. Thus, if you don’t miss any mortgage payments prior to selling your home short, you can expect the short sale to damage your credit less than a foreclosure.

How Banks Report Short Sales

Many former homeowners are shocked and confused when they discover that a previous short sale appears as a foreclosure on their credit reports. Unfortunately, it’s a fairly common practice for banks to report short sales as foreclosures to the credit bureaus. All information creditors report to the credit bureaus receives a code. There is no code for a short sale. As a result, banks will often report a successful short sale as either a foreclosure or a settlement.

Although the credit damage resulting from a foreclosure report is roughly the same as that resulting from a short sale report, the bank’s erroneous reporting can carry additional consequences if you plan to buy a new home in the near future. Freddie Mac and Fannie Mae guidelines note that consumers who previously participated in a short sale are eligible to purchase another home in as little as two years. Those with a foreclosure on their records, however, may need to wait as long as seven years before purchasing another home.

Credit Impact of a Short Sale

The FICO scoring formula used by the Fair Isaac Corporation to calculate credit scores is an industry secret. Because the credit impact of any given item is dependent on this formula, the credit damage you sustain from a short sale may differ considerably from the credit damage another individual sustains. In general, however, you can expect to lose 150 points or more when a short sale appears on your credit report. You’ll face additional credit damage if you missed any mortgage payments prior to the short sale.

A short sale on your credit report can decimate your scores, but the damage doesn’t have to be permanent. If you continue to pay your other creditors on time, your credit scores will gradually recover. Regardless of whether the bank reported your short sale as a foreclosure or a settlement, the credit bureaus will remove the short sale from your credit history after seven years. Once removed, the short sale no longer affects your credit rating or poses an obstacle when you apply for a new loan.

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