How Does a Short Sale Hurt Your Credit?
A short sale is otherwise referred to as a pre-foreclosure. With the short sale process, a lender agrees with a seller to settle the mortgage debt for less than the balance, pending a successful sale to a new buyer. However, while a short sale does avoid the negative credit consequences of a foreclosure, it does harm the consumer's credit.
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Impact of a Foreclosure
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When a bank forecloses on a home and repossesses it, the impact of a foreclosure filing can decrease a credit score by as much as 200 points. While the negative impact of a foreclosure won't appear on a credit report for 30 days after the foreclosure has been completed, the effects of the filing will result in a consumer being unable to obtaining future credit for several years.
Impact of a Short Sale
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While a short sale allows the home owner to settle the debt for less than the balance, his credit report will still suffer a negative impact. Not only will missed or late mortgage payments (normally occurring prior to a short sale agreement and being the reasons for pre-foreclosure status) have a negative effect, but a short sale shows that the home owner almost lost the home due to financial difficulties. While the short sale does not have the same negative result as a foreclosure, it will drop a consumer's credit score by as much as 100 points.
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Deficiency
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In a foreclosure, a lender has an option to file a judgment against the borrower to collect on the difference between the mortgage balance and what the property sold for. For example, if the borrower owed $100,000 and the property sold for $60,000, the judgment would be $40,000.
In a short sale agreement, the lender waives the right to file a judgment against the borrower. In the event of a successful short sale, the deficient amount will be a tax write-off for the lender, and the borrower will not have to worry about a judgment following her on her credit report.
If a Short Sale Doesn't Work
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There are instances where a short sale is not successful, and the house doesn't sell. In these cases, the bank will proceed with a foreclosure. In most cases, the bank will allow the seller six months to sell the house before foreclosing.
Even if the short sale agreement was in place with the seller, the foreclosure makes that agreement null and void. At this point the bank is free to pursue collection activity and file a judgment for the deficient balance after the house is sold either at auction or on the open market as a real estate owned property.
Taxes
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If a short sale is successful, even though the bank will not file a deficiency judgment against the borrower, there are tax consequences of the short sale. At the end of the calendar year, the mortgage company will send the borrower a 1099 form. The deficiency amount is counted as additional income that he will be charged. In this case, if he owes money and does not pay the amount owed to the IRS, the IRS can pursue collection activity that will also negatively impact the consumer's credit.
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References
- Photo Credit sale image by petar Ishmeriev from Fotolia.com
