Short sale or foreclosure? Short sale … or foreclosure? What should I do?
That was the unhappy decision a lot of distressed home owners had to make during the Great Recession when real estate values plummeted like a coin tossed in a cup of water.
Foreclosure offered a short-term solution – you could live rent free for a few months until the foreclosure process ran its course – but short sales was the better long-term solution because it allowed you to re-enter the housing market in just two years.
Approximately 8.7 million homeowners chose short sales – selling their homes for less than what was owed on the mortgage – 2008 to 2018. The numbers have been on a decline since peaking at 1.15 million in 2011, but it’s still an option for people who wade into the housing market and quickly find out they’re going underwater.
What Is a Short Sale?
In a short sale, you attempt to sell your home for less than you owe – if the lender agrees to allow it to happen. If the house sells, the lender pockets the proceeds. Not all lenders will agree to a short sale. In fact, homeowners usually have to be 90 days late or more for the lender to even consider the idea.
Some lenders might not forgive the unpaid balance on the mortgage. Some state laws allow lenders to seek deficiency judgments that force you to repay the difference between the sale price and the balance due on the mortgage.
Lenders will report the short sale to the three major credit bureaus as a charge off, a settlement, a deed-in-lieu of foreclosure or a loan settled for less than the amount due. The way the lenders report the short sale also can have a significant impact on the damage to your credit score.
In addition, any late mortgage payments you made before the sale will further undermine your score. Finally, if the lender obtains a deficiency judgment to collect the balance of the mortgage, that also will damage your score. The amount of the deficiency can also impact your credit score.
How Does a Short Sale Impact Your Credit
A short sale will blow a hole in your credit score, dropping it as much as 100-150 points, depending on where you started. The higher your credit score, the more you will fall.
Rod Griffin, Director of Public Education for Experian, one of the three major credit reporting bureaus in the U.S., said: “Short sales, are among the worst things that can happen to your credit score.”
“The specific amount your score drops depends on your credit history, the scoring system being used and what the lender’s criteria are,” Griffin added, “but it definitely will have a very serious negative effect.”
Credit scorestypically range from 300 to 850. If your score is in the 750-800 range, it could easily drop 150 points in a short sale, maybe even more. If you have an average or even good credit score (something in the 650-720 range), you could lose 100 points after a short sale and fall into what lenders call “subprime” category.
Why is this important?A lower score can make borrowing more difficult, if not impossible. Even if you are still eligible for credit or loans, your interest rate will climb as your credit score drops.
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How to Rebound from a Short Sale
Though foreclosures and short sales can both severely damage a credit score, continuing to make mortgage payments until a short sale closes might offer a path to an early rebound. In many cases, you’ll be able to obtain a mortgage for a new home in two years, and even less time if you continued paying the mortgage until your house sold, as opposed to five to seven years after a foreclosure.
Short sales, like foreclosures, can remain on your credit report for as long as seven years. The silver lining with short sales is that your score is likely to begin improving more quickly, usually in about two years. But there are things you can do to speed the process.
The most important step is focusing on your consumer credit. Keep your credit card balances low and, always pay your bills on time. If you have credit card debt, try to pay it down, since it accounts for 30% of you credit score. If you don’t have revolving consumer credit, try to open an account. Many lenders will issue a secured credit card, allowing you to make a deposit to secure your card against the purchases you make. Paying statements on time will enhance your creditworthiness.
“If there is on-time repayment information reported on your accounts, that is a positive and will help offset the negative caused by a short sale,” Griffin said.
If you are having trouble juggling all these choices, it might help to call an nonprofit credit counseling agency. The counselors there are experienced at providing debt-relief services and their advice is free.
Ultimately, only time will remove a short sale from a credit report, but you should do everything in your power to demonstrate you can manage credit well.
The Waiting Period
Many people worry about one thing when they lose a house in a short sale: How long will it take before I can buy another? Unfortunately, there isn’t one answer that fits all. The unpaid balance of your loan after you sold the house is one factor. Another is whether you were late in any payments before the sale.
The payment issue is very important. It’s vital to keep paying your mortgage until the short sale closes. If you were current, you could qualify for a Federal Housing Administration (FHA) mortgage immediately after the sale is completed. Fannie Mae, a government-chartered company that buys mortgages that lenders write, has a similar program. Not all lenders, however, will lend you money after a short sale, so you need to make inquiries until you find one.
If you were delinquent in making payments on the home you short sold, most lenders will make you wait at least two years before applying for another mortgage.
Short Sale vs. Foreclosure
If short sales and foreclosures each had exactly the same impact on your finances, hardly anybody would bother with the sale. But there are differences, the biggest being the potential impact on your credit score.
Think of a short sale as a negotiated exit from a mortgage, while foreclosure is more like surrender. Foreclosure means you stopped making payments and the lender had to go to court and get a judgment against you to get the house back and maybe recover some of the debt.
A short sale can benefit a lender. You become a partner in the sale of the property and, in states where it is harder for lenders to foreclose, it can have real advantages for the mortgagee.
Agreeing to a short sale is agreeing to a settlement, and settlements are negotiated. You should push the lender for the best terms available. See if you can report the mortgage as paid instead of settled. A settlement tells the credit bureau that the lender accepted less money that it was owed. Paid, by contrast, doesn’t contain that inference, and it would have much less impact on your credit score. Lenders receiving less money than they are owed rarely go for this, but they might if you never missed payments and wrote a convincing hardship letter when requesting the short sale.
Ultimately, the impact on your credit is in the hands of the credit-reporting bureaus. Though some market experts say there is no credit-scoring difference between a short sale reported as a settlement and a foreclosure, others suggest that short sales can have benefits.
Experian’s Griffin said: “With a short sale, at least you are repaying a portion of the mortgage. A short sale is slightly less bad than a foreclosure and a foreclosure is slightly less bad than bankruptcy.”
Letting your loan go into foreclosure means you stopped paying your mortgage. That could degrade your credit score faster than if you continued paying until the home was sold at a loss. Lenders have a legal right to pursue you for the unpaid balance, and their legal actions can further damage your credit. If you can do a short sale and your lender agrees to it, negotiate how it will be handled and there’s a chance your credit score will benefit.
Like most financial decisions, whether to allow foreclosure or sell short requires you to weigh the options. A foreclosure will surely damage your credit, the result of both the foreclosure and the months you are delinquent on your mortgage before the foreclosure occurs.
But a short sale also has costs. You need a contract with a real estate agent and your house must be presentable to potential buyers. You also need to petition your lender to allow the sale, which involves writing a letter explaining your financial hardship and then living by the terms the lender demands.
Finally, short sales have potential tax implications. The Internal Revenue Service considers any debt the lender forgives to be income, meaning it’s taxable. Some federal and state programs are available to mitigate the tax consequences that come with a short sale.
Delinquency
Avoiding payment delinquency is the best thing you can do before and during a short sale. Credit bureaus use formulas, and the longer a payment is delinquent, the more credit score points you lose. Getting those points back requires time and solid payments in the future. The easiest way to avoid this problem is to keep making timely payments.
In the end, short sales are almost always damaging to your credit, but they do less harm than foreclosures or bankruptcies. A short sale might block you from a mortgage on a new home for two years or so, but a foreclosure or bankruptcy could keep you out of the market for as long as seven to 10 years. Even if you must wait two or more years, it’s an opportunity to improve your credit score through good financial behavior and that could mean a better interest rate the next time you buy a home.
