The Effects of a Short Sale on Your Credit Rating

Although a short sale of your home will lower your credit rating, it can help you avoid a more negative impact by keeping a foreclosure off of it. It is important to understand how a short sale works, how your credit rating works and what effect a short sale will have.

How a Short Sale Works

If a homeowner falls behind on mortgage payments, the lender can declare the borrower in default and force a foreclosure, which means legally taking the home from the homeowner and selling it at auction.

In a short sale, a borrower approaches a lender with an alternative to foreclosure. It is assumed the borrower is behind in mortgage payments and will be unable to get ahead.  The borrower and lender then agree to appraise the house and sell it, applying the proceeds of the sale to the mortgage. A lender cannot approach a borrower about selling short. Additionally, to be considered for a short sale, the borrower must be facing unavoidable financial hardship, simply wanting out of a mortgage is not reason enough. A job loss would be a cause, as an example.

How Your Credit Rating Works

Anyone who borrowers from a legitimate commercial lender has the loan and payment history reported to the three primary U.S. credit reporting bureaus. These are called Experian, Equifax and TransUnion.

Your credit history is an ongoing record of your borrowing and payment history, including any negative information such as late payments, charge offs, defaults, foreclosures and bankruptcies. 

Your credit score, or credit rating, is calculated by the Fair Isaac Corp. based largely on your credit history.

Impact of a Short Sale

A lender will report a short sale on your credit history and the immediate impact is about a 50-point drop. As negative as this is, it also ends the negative effects of missed payments. In most cases, a lender will not consider you for a short sale if you are current on your loan, so it is assumed you already have late payments when you request the short sale. These late payments are showing up on your credit report monthly, lowering your credit rating. Negative information remains on your credit history for three years.

Avoiding Foreclosure

Despite the lowering of your credit rating by a short sale, it does not lower it as much as a foreclosure would. To measure this impact, consider that the median credit score in the U.S. is 720. A score of 620 means you are a subprime borrower. A foreclosure can immediately knock between 100 and 140 points off your score. Additionally, a foreclosure stays on your credit report for seven years.

Seller Beware

A short sale is not a guaranteed salvation for your credit score. The short sale will be approved for an offer of about 90 percent of the home’s appraised value. But that likely will not cover the entire amount of your outstanding mortgage. Most lenders accept the sale proceeds as paying your mortgage in full, but they are not required to. Even with a successful short sale, you could still be liable for the portion of your mortgage not covered by the sale.