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How Will a Short Sale Affect my Credit?

If you need to sell your home for any reason and you are like most of San Diego’s 30% of “underwater” homeowners who owe more on their homes than they are worth, then a short sale is most likely your best solution.  However, good sense bears the question, “How Will a Short Sale Affect my Credit?” 

A quick internet search of “What does a short sale do to your credit” will reveal 76,500,000 (yes, that’s 76.5 million) results.  The interesting part is that the answers vary from one to the next.  So, let’s look into this deeper to settle the truth.

Whether it be a mortgage, a credit card, a car loan, or a student loan, the credit report reflects (1.) your monthly payment history, and (2.) the current status of the credit account.  For example, an auto loan from 5 years ago that has since been paid off, will show each month’s payment status (Paid on time, Not Paid, Paid 30-days late, etc.) as well as the loan’s current status (which in this case would be Paid in Full/Closed).  Both reporting items of each loan have an effect on your credit score.

Credit Score.

Defaulted Mortgage Payments –

A foreclosure is only triggered by an accumulation of unpaid mortgage payments, meaning that payments are not paid to the lender.  A short sale is typically used an alternative to avoid foreclosure.  Therefore, typically once a homeowner has initiated a short sale, several (or many) mortgage payments have been missed.  The reason that “typically” continues to be used, is that a mortgage payment does not need to be missed in order to qualify for a short sale.  Therefore, the effects of a short sale could be very minimal, and in other instances can be more damaging. 

In the first situation, a homeowner may not be in a severe financial hardship that actually impedes the ability to pay the mortgage payment.  Because of the fact that the homeowner in this situation is not missing mortgage payments, the credit effects will much less severe as a result.  A lender may approve a short sale while a homeowner keeps their mortgage payments current for situations such as job relocation. 

In the latter situation, which is the more typical, a homeowner has already begun missing mortgage payments.  Upon missing 1 or more mortgage payments, the homeowner begins a short sale.  [Note that most of our clients have already missed many mortgage payments before contacting us for short sale assistance].  Once the mortgage payments have become unpaid and defaulted, the monthly late payments are reported to credit bureaus, which ultimately affect the credit score.  In summary, the more payments missed, the greater the impact on the credit score.

Recent research and simulated models as produced by FICO showed that a consumer credit profile with no deficiency balance (remember, no deficiencies in CA; see CA SB-458) caused the score to drop by 35-55 LESS points in comparison to a foreclosure’s impact.  35-55 points on your credit profile could equate to as much as 3-years of extra time to rebuild your credit score.  As you can see, this will also play directly into how long before you are able to qualify for another home loan, as well as other types of credit.

Short Sale Reported As… –

The other impact on your credit is how the credit account (mortgage loan) is reported to the credit bureaus.  In the example above, an auto loan from 5 years ago that has since been paid off is reported as Paid in Full/Closed.  So what happens when a short sale is approved by the lender, the buyer funds the sale, and escrow has closed?

You can expect a loan that has been foreclosed on to be reported as Foreclosure on the credit report.  However, there is no such single designation for a short sale on a credit report.  Every lender will report the account to the credit bureaus a bit different.  This can range from Less than Originally Agreed to Charge-Off to Deed-in-Lieu of Foreclosure.  This too factors into how the short sale affects a credit score.  In some occasions, the way in which the short sale is reported can be negotiated with the short sale lender.  Make sure your short sale Realtor® has experience in negotiating the best for your.

Furthermore, a recent change to the government-sponsored program, HAFA short sale program, has helped define and direct how the short sale is to be reported to credit bureaus.  This directive from the new HAFA Supplement to Handbook allows for the impact to be less severe as a result of the status reporting.  Quoting from the HAFA Supplemental Directive 12-02 (page 19):

The requirements in Section 11.2, Chapter IV of the Handbook related to credit bureau
reporting of HAFA transactions are amended as follows:

If the real estate is sold for less than the full balance owed and the deficiency
balance is forgiven, report the following Base Segment fields as specified:

Account Status Code = 13 (Paid or closed account/zero balance) or 65 (Account
paid in full/a foreclosure was started), as applicable.

This directive’s clarification mandates lenders to report the HAFA short sale as either Paid or Closed or Zero Balance.  Either of those are far more beneficial than any of the other typical reporting statuses.

Do you qualify for a HAFA short sale?  Contact us to see.

Beyond the Credit Score.

The credit score implications are not the end of the story.  Your credit is a profile.  When a lender looks at a loan applicant’s credit, they are not strictly looking at the score itself.  They are looking at other factors of your credit profile.  This typically includes if and when you’ve had a bankruptcy filing, or if and when you’ve participated in consumer credit counseling.  They are also reviewing your credit profile for collections, charged-off accounts, and even status of marital/child support payments.  Due to the recent resurgence of foreclosures and short sales, the “if and when” of a foreclosure or short sale has become one of the largest effects of the credit profile.

Foreclosure vs Short Sale –

Generally speaking, a foreclosure prevents someone from being eligible for a new mortgage for about 5 years (7-years in extreme cases).  Conversely, to obtain a new mortgage after a short sale, the requirement has been recently reduced to 2-years from the date of short sale.  [ FHA Guidelines | Fannie Mae Guidelines ]

That is a substantial difference, further proving that the overall affect that a short sale has on a credit profile is much better than that of the havoc that a foreclosure wreaks on a credit profile!

 

In our opinion, the best way to make a prudent decision is to educate yourself. Keep reading…

Contact us for help in understanding and establishing your best solution.

The information contained herein has been provided by San Diego Board of REALTORS®. This information is from sources deemed reliable but not guaranteed by San Diego Board of REALTORS®. The information is for consumers' personal, non-commerical use, and may not be used for any purpose other than identifying properties which consumers may be interested in purchasing.

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