Does a Short Sale Damage Credit?
Short sales occur when a home sells for less than the outstanding mortgage. In an attempt to protect credit scores, home sellers sometimes decide to do a short sale to avoid foreclosure. The process takes from two weeks to five months, and in the end, the homeowner's credit report is still affected.
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Credit Scores
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A credit score, often called FICO score, is a moving target that changes on a monthly basis. Scores from the three main credit reporting agencies, Equifax, Experian and TransUnion, all contribute to the overall FICO score. Late payments, delinquent accounts and bankruptcies all impact a score negatively. Credit scores dictate the interest rate a buyer may receive from a bank for a loan or credit card. Employers, landlords and utility companies use credit scores to determine an applicant's "worthiness." Typically by the time a seller is contemplating a short sale he has a number of late payments already on his credit report.
Short Sales Effect on Credit
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Foreclosures and short sales both affect a credit report negatively. There is no designation for a short sale on credit reports, so these sales reflect as "settled" or "full amount not paid." In some cases the bank offers the seller a promissory note to pay the difference between the short sale and the amount owed. This can result in a credit designation of "paid in full," which does not have a negative effect, but it is not an option for most sellers due to their financial state. A delinquent seller entering into a short sale may discover that his credit rating is not that badly affected, but this is because the rating was already low. A seller with up-to-date payments can potentially take a harder hit. According to Experian, one of the top three credit reporting agencies, late mortgage payments remain on a credit report for seven years.
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Alternatives
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The biggest alternative to a short sale is foreclosure, which remains on a credit report for seven years. Deed in lieu of foreclosure impacts the credit report for seven years as well. Homeowners with multiple debts sometimes choose bankruptcy, which is the worst option in regards to credit report impact. A short sale or foreclosure is a single account on the report, while bankruptcy affects several accounts and is viewed more negatively by creditors. Talking to the lender about refinancing may be an option as well. Programs are available to lower monthly home payments.
Making Homes Affordable Program
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The federal government offers programs to homeowners looking for alternatives to short sales. The Home Affordable Modification Program gives financial incentives to mortgage lenders who modify existing liens to help homeowners avoid foreclosures. The Home Affordable Refinance Program is a refinance program for mortgages guaranteed by Fannie Mae or Freddie Mac. Both options allow the homeowner to remain in the home while lowering the house payment. There is still an impact to the credit report although it is not nearly as negative as a foreclosure or short sale. The bank designates the loan as "modified under federal government plan."
Improving a Credit Score
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Short sales impact a credit report for up to seven years as do the delinquent payments that most likely preceded the sale. The good news is that a credit report is a snapshot of current creditworthiness. Making debt payments on time and keeping balances low is a must for rebuilding credit. Although the negative history will still be present, its impact diminishes with time. Some homebuyers may qualify for a mortgage in two years after the short sale, depending on the state of their credit prior to the sale.
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