How Does a Short Sale Affect the Homeowners’ Credit?

How Does a Short Sale Affect a Credit Score?

The #1 question my students are asked by distressed homeowners is: How does a short sale affect my credit score? Let’s define what a credit score is first before we embark on how a short sale affects your score.

Your credit score is actually a formula developed and maintained by a private company called Fair Isaac Company, Inc. The score is determined on a weighted scale with:

  • Payment History, and

  • Amounts Owed

weighted far heavier than…

  • Length of Credit History

  • New Credit, and

  • Types of Credit Used

[See FICO Basics for a more detailed explanation.]

Since Fair Isaac invented and continues to maintain the credit score formula, naturally we should ask them how a short sale affects a credit score. The question posed to was:

“How does a foreclosure or short sale affect my score?”

Their response was:

“Credit bureau reports are limited in how they represent foreclosures today, so it’s generally not possible to tell from the credit report if a reported foreclosure is a short sale, deed in lieu of foreclosure, settled account, regular foreclosure, or some other variation.

The FICO score treats all of these descriptions that appear on credit reports as serious delinquencies, so they have an impact on the score similar to the impact from a charge off, tax lien, or account included in bankruptcy.”

Not what you were hoping for, huh? Well, in another article, “Why a Short Sale is Better Than a Foreclosure,” I’ll describe the massive benefits of a short sale over letting the property go to foreclosure.

[As it turns out, the credit score itself is not necessarily helped by a short sale over any other seriously delinquent account, such as a foreclosure. So the initial score decrease will be the same–experts say a ballpark of 100-200 points on a scale of 300 to 850. And the higher the credit score the greater the fall.]

But the credit report itself looks far better. Most underwriters agree that a short sale looks better than a foreclosure on a credit report. When you’re doing a short sale, it shows that you’ve actually done something about the foreclosure, versus letting it go to foreclosure.

In fact, FHA has developed a loan program just for borrowers who have had a short sale.

There is one way to minimize your credit score reduction when dealing with a short sale. Try to avoid allowing the payments to go behind. That maybe easier said than done, and I know that sounds like an oxymoron–doing a short sale while keeping the payments current, but it can be done.

My students and I do those all the time. The most destructive item to your credit score is the late payments. When it shows 30 days late, then 60, then 90, then 120+ days late, that’s when the credit score takes it’s biggest hit.

So if you can squeak by and keep the payments from falling 30 days late, you stand to really minimize the damage to your score from a short sale.

How Does a Short Sale Affect a Credit Report?

It is a very hot topic: How does a short sale affects your credit report? Let’s have an inside look at what a short sale does to your credit report.

After a short sale transaction is complete, the lender is going to report to the three credit bureaus (Equifax, TransUnion, and Experian) that a short sale was conducted on the loan, as opposed to a full payoff.

Although lenders are subject to change their policies on a moment’s notice, we have seen Countrywide report, “settled as agreed,” Litton Loan Servicing report “account settled,” HFC Beneficial report “settlement in full,” and HSBC report, “Account legally paid in full for less than the full balance.”

This terminology is very similar to what credit card companies report when a borrower settles an old collection for a percentage of the total amount owed.

In most cases, the short sale approval letter will specify the exact wording the lender is going to report to the bureaus. In isolated cases, you may find where the short sale approval letter does not specify how the short sale will be reported. In such cases, you should contact the department handling the short sale to determine how it is going to be handled.

Also, we have seen some cases where lenders fail to report a short sale to the credit bureaus, for who knows what reason. Maybe they forgot?

And if the account is more than 120 days past due, many times it will automatically show up as a “foreclosure” on the credit report. Therefore, it is imperative that you follow up with all three credit reporting bureaus a month or two after the short sale is complete to verify with all three credit bureaus that a “foreclosure” is not showing up.

In such cases, you may have to provide evidence to Equifax, TransUnion, and Experian to prove that indeed the property was sold prior to a foreclosure.

I hope this helps you understand how a short sale affects a credit score and a credit report. Stay tuned for: “Why a Short Sale is Better Than a Foreclosure.”

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