Short Sale & Your Credit Score

UpdatedJan 24, 2008

Key Takeaways:

Understand whether or not you will be responsible for a deficiency balance prior to finalizing your short sale.
Compare the effects on your credit rating of a foreclosure to those of short sale.
Speak with an experienced attorney, before you decide to pursue a short sale..

How will a short sale of my home affect my credit?

Editor’s note: See the Bills.com resource Short Sale, Foreclosure & Your Credit Score to see Fair Isaac & Co.'s answer to this question.

Generally speaking, a short sale occurs when a homeowner who is behind on his or her mortgage payments, and who owes more on his home than it is currently worth, contacts the mortgage lender asking the lender to allow him to sell the home for less than the balance of the mortgage.

For example, if you owe $100,000 on your mortgage, but are only able to sell your home for $80,000, you would need to have your mortgage lender agree ahead of time to allow the sale to proceed. In fact, there is little use in putting your home on the market until you, or your attorney, have spoken with your mortgage company's loss mitigation department to discuss proceeding with a short sale.

Many lenders will authorize short sales in an attempt to prevent property from falling into foreclosure; however, some lenders will not allow short sales to proceed. Usually, no lender will authorize a short sale unless the borrower is already in arrears on his mortgage, as the lender will see this as evidence that the borrower can no longer afford the home. In addition, your mortgage lender's loss mitigation team will probably want to see documentation of your income and assets to verify that a financial hardship exists and that you truly cannot afford the home.

If your mortgage lender approves a short sale, the next step is to find a buyer willing to pay a reasonable price for the property. Some people try to take advantage of individuals who are trying to conduct a short sale by offering significantly less than the home is worth, hoping that the owner will accept the offer out of desperation. Once an offer is made on the home, you will need to consult with your lender, and the lender will have final say-so in whether or not the sale can proceed at the offered amount. When first talking to the loss mitigation department, you may want to inquire as to what amount the mortgage lender considers reasonable so you can gauge what offers you can expect to have approved.

If you are successful in selling your home in a short sale, you may still be liable for the difference between the amount you owed on the mortgage and the amount of the sale. This is referred to as a deficiency balance.

If you owe a deficiency balance, your lender may be able to pursue you for collection of the debt, depending on your state's laws regarding deficiency balances on homes. Some states, such as California, do not allow for the collection of deficiency balances on purchase money loans. However, if you live in a state which does allow for the collection of deficiency balances, your creditor may be able to sue you and obtain a judgment for the amount owed.

Many creditors do not pursue former homeowners for deficiency balances even in states where they are allowed to do so, preferring to use the loss as a tax write-off. I encourage you to discuss this with your mortgage holder and an experienced real-estate attorney prior to proceeding with a short sale. An experienced attorney should be able advise you of your state's laws and may also be able to assist you in negotiating with your mortgage lender.

Credit Score

In regards to your credit score, the negative credit impact of a short sale is less than that of a foreclosure. A short sale will not appear as a foreclosure on your credit report, and therefore only the previous delinquency on your mortgage will appear. Also, I believe that most mortgage lenders report a mortgage that is paid through a short sale as being in a redemption status.

Although the delinquency and change of status on your mortgage loan will certainly lower your credit rating, from my experience, the negative impact is less than the negative credit implications of an actual foreclosure. If you must choose between a short sale and allowing your home to go into foreclosure, from a credit perspective, a short sale is the wiser choice.

Again, I encourage you to speak with an experienced real estate attorney to discuss the details of your situation to help you determine the best course of action in your circumstances. To learn more about foreclosure, short sales, and other options available to homeowners struggling to meet their mortgage payments, I encourage you to visit the Bills.com Foreclosure page.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

10 Comments

DDowney, Jul, 2013

I purchased a Florida investment property with a partner who bailed out on me. Unfortunately for me, the loan is in my name only, and I have defaulted. The lender is asking me to provide proof of income and tax reports. My income is clearly high enough to be able to afford the loan, but is not what I am interested in as the property is worth less than 50% of the loan value. What are my options? Will me providing the financial disclosure impact the outcome? My lawyer encourages me to do so, but I am reluctant. I do not reside in FL, so they would have to sue me in a different state for deficiency.

BBill, Jul, 2013

I encourage you to follow your lawyer's counsel. In my opinion, the fact that you have the income to afford the payments on the loan on which you defaulted, increases the likelihood that they will sue you. Cooperating with them may make it likelier that they will settle the debt with you at a reduced rate, rather than sue you.

EElle, Jul, 2012

So here is my dilema/situation...I am currently underwater by 50% (even after a complete kitchen renovation) and am struggling to make payments. I am consistantly one payment behind for the last year and couple months. I recently had to upgrade my vehicle ( I upgraded modestly) but, after 7 years of not having a car pament and cheap insurance the increase has taken its toll. I have not had a raise in over 10 years so things are starting to pile up, and to add to that I regretably took out a small personal loan with a high interest rate to catch up. My current score is right around 600. Now after bearing all (for the first time out loud, sigh) I have located a house for sale by our city in my dream neighborhood historic district that recently had gone through some extensive water damage with a broken pipe and was left to sit with the basement full and a foot or two of water up on the first floor. I am no stranger to a hammer and nails and I love to restore the damaged old in our world so I am not shy about the work that will need to be done, nor afraid to hire when I realize I may be out of my depth project-wise. My question is, what are my options? Can I short sell my home and still be able to obtain a rehab loan of sorts for the new property? (My parents offered to take me in if it is only a matter of a couple months) I guess I should state that the rehab loan (to summerize all those loan terms) would be at least 20-30 thousand less than my current mortgage. I also should add that I do not have much available to put towards a down payment (under 3,000).I am dying (to put it lightly) to get out of my current neighborhood as it has taken a turn for the worse the last 5 years and, I am a single woman that would feel a little more comfortable elsewhere.-Signed, Desperately in need of inheriting a hidden family forturne

BBill, Jul, 2012

When is the last time that you missed a payment? Depending on the type of loan you have, you might be eligible for a refinance loan (HARP or FHA streamline), a loan modification (HAMP or bank modification), or perhaps a short sale program (HAFA).

If you want to do a short sale, then you will have to speak to your lender. You will want to see how much principal reduction the lender will agree to and also if your deficiency balance is subject to any anti-deficiency non-recourse laws.

If you are current on your loan it is possible that you can get a FHA 203k loan, although this will also depend on your other debts, including how you finalize a short sale. Your maximum loan would be about $96,000 based on a FHA loan which requires at least a 3.5% down payment. You would also need money for the closing costs.

I recommend that you start by speaking with your servicer about a refinance (if you are eligible for a HARP mortgage) or a loan modification, that will allow you to lengthen your loan to more affordable payments. You might also look into a credit counseling plan to help you manage your other debts.

AAnthony, Mar, 2012

My situation is almost exactly the same as what Jason S. posted. My condo is very underwater. My HOA will not allow me to rent it out because they have reached the rental ceiling for our community. I am planning to refi if possible with harp 2.0. That might help lower my payment a little but it will not help me with the major issue which is that my wife and I could easily afford a mortgage payment on a luxurious single family home 3x the size of my current condo if I wasn't tied down by this condo, with no hope of getting back to its original price within the next 5-7 years.I've been scouring the internet trying to find a solution, but I keep reading the same answers: the conservative folks say "pay your mortgage and be grateful!", the liberal folks say "bail out". I just wish there was some way to cut ties with my current place and not feel guilty for further screwing up my neighbor's property value. I REALLY don't want to miss out on the opportunity of historic low interest rates and much lower home prices that will benefit us for at least the next 30 years! I bought my current place in 2005 right around the worst time unknowingly to me and all others. And now is the worst time NOT to buy a home.I don't know if there's anything new you can tell me that I haven't already read. I guess I'm just writing all this to say I'm frustrated and show solidarity with everyone else in my boat..or submarine actually. Thanks.

BBill, Mar, 2012

Anthony, I admire the consideration and concern you have for how your actions could affect your neighbors. I think that it is worth factoring in your decision. At the same time, you should look at all your options.

For instance, if you have a non-recourse loan, working to negotiate a short sale or walking away from the home may make sense. Other factors to consider are: what your HARP mortgage payment will be, what rents in your area are, would you be happy renting until your credit improved (should you walk away or do a short sale) enough to buy another home.

JJason, Mar, 2012

My current situation is as follows: I (my name is the only name on the loan(s), not my wife's) am currently underwater on my home by about $35K. My 1st (and 2nd) mortgage is NOT serviced by either Fannie or Freddie, therefore (at this time) I'm not eligible to refi under HARP. I am current on payments and can afford to continue to make them going forward.My question is this: going forward, having a growing family with a need for a larger home and the income between my wife and I to be able to afford a larger home (if not for my current, underwater home), what options/suggestions do I have?

BBill, Mar, 2012

I have no bright ideas or tidy, pain-free options for you. My best idea? You mentioned you alone are on the existing loan, which leaves your spouse as a credit score lifeboat if you cannot exit the loans cleanly. Allow me to explain: Let us say your spouse qualifies for a home loan alone, without including you as a co-signer. She buys the new house in her name. Meanwhile, you quit the old house and either short-sell it or if the mortgage servicer is not reasonable, allow a strategic default. Worse-case scenario, the lender(s) files a lawsuit against you for the deficiency balance, and you either negotiate a reasonable settlement or file for bankruptcy that will discharge the deficiency.

JJason, Mar, 2012

I appreciate your response. I was thinking similarly to your suggestions. Along those lines, in an attempt to avoid paying the deficiency to my lender after a Short Sale, are lenders (B of A, in this case) willing to get creative in order to maintain business. By "creative" I mean more specifically, would a place like B of A be willing to forgive the deficiency owed on my part if my spouse, purchasing another property without my co-sign, was willing to purchase through their lending? It may be analyzing apples (me) and oranges (my spouse), but I'm curious if you've ever witnessed any type of "arrangement" like this before?

BBill, Mar, 2012

A mortgage servicer, such as Bank of America rarely, if ever, owns its home loans. A mortgage servicer has a fiduciary duty to each of its loan investors. That means it cannot put its own interest, or the interest of another investor, above any other investor.

What you suggest would place the investor of the old loan at a disadvantage to the new investor.