If you are behind on your mortgage payments and the lender threatens foreclosure, a short sale could save you money and reduce the chances of future litigation. Like any debt settlement, a short sale will severely damage your credit. A short sale, however, will not prevent you from getting credit again even if it ruins your credit for a couple of years.
Score Drop
Short sales, foreclosure and deed-in-lieu of foreclosure all drop credit scores by 200 points or more, because they show the lender you could not handle a large loan. The actual impact on your score depends on your rating prior to the short sale; high scores take a bigger hit than low scores.
How Bad is This?
If you already have excellent credit--close to 760--a short sale leaves you in the range of 560 to 580, which puts you into the highest risk category. FICO scores, however, treat short sales better than foreclosures and you can probably find another mortgage if you have good payment history for the next year or two. With foreclosure, it will take at least three years to qualify for a mortgage again.
Considerations
Most lenders will not approve of a short sale until the mortgage goes into default. Also, many people simply stop paying money on a home they know they will lose anyway. These months of late payments do additional damage to your credit score. A lot of the lingering effects of short sales depends on how the lender reports it. If the short sale does not cover enough of the mortgage, the lender could report the deficient balance as unpaid, unless you live in a state that eliminates deficiencies on foreclosure and short sales--called a non-recourse loan. Unpaid balances will damage your score further.
Do You Have a Choice?
Most of the time, if you let your mortgage payments fall behind by more than 180 days, the lender has the majority of the power to decide whether to foreclose or approve a short sale. The Boston Globe suggests listing a home as a short sale as soon as you expect to lose your house so you can find a buyer quickly and then present the offer to your bank.
If the bank approves your short sale, consider hiring an attorney to ensure the provisions of the short sale include a waiver of liability for any potential expenses, such as property tax and deficient balances.
Tip
Try to fix whatever problems led to the short sale. If you overspend, cut out frivolous expenses, such as eating out, and pay down any other debts. Good payment history is the biggest factor in your credit score. A new line of credit could help build excellent credit on a new account. You probably, however, only qualify for a secured credit card, with a credit line based on whatever collateral you put up. Just make sure to use less than 30 percent of your available credit.
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