A short sale may save you from the added expenses of a foreclosure, but it probably won't save your credit score. In a short sale, the bank agrees to let you sell the house for whatever you can get and then call off the mortgage. Because most short sales do not pay off the entire mortgage, the agencies will report the debt as delinquent.
Identification
Like any item on a credit report, a short sale has an unpredictable effect on any borrower's credit score, because the FICO scoring formula is a secret. With what is known about the FICO system, negative items like a short sale take away more points as you climb up to the top score of 850. When Fair Isaac released a study of consumers in 2010, it found a short sale took off 85 to 105 points on an average score of 680 and 140 to 160 points on a score of 780, according to CNN.
Is This Better Than Foreclosure?
As far as credit scoring goes, foreclosure, short sale and giving up the deed to the property in lieu of foreclosure have the same effect, because they all result from the borrower repaying the bank less than what he borrowed. Actually, the credit bureaus do not use short sale, instead listing the account as "settled." A short sale could have a neutral effect on a credit score if the sale repays the entire mortgage. Then the creditor can report the account as "paid as agreed."
Considerations
Banks do not go to foreclosure until the borrower misses a few payments in a row, usually between three and six. These missed payments cause almost as much damage as the foreclosure, because they are a serious incident. The lender could agree to a short sale and the borrower would have no negative history on the account until the short sale occurs as long as he meets the minimum payment. If the short sale is the only thing on your report and you have a score of 780 before the short sale, you would probably have good enough creditworthiness to get new credit and possibly another mortgage, but at much worse terms.
Tip
Consult on an attorney about how the creditor will report the short sale to the credit bureaus. Some lenders may agree to report the account as "paid as agreed" in return for some concessions. Also, do not forget about the tax implication of forgiven debt. If the lender forgives $50,000 on the mortgage, the IRS considers this $50,000 in income. Not paying your IRS bill could result in a tax lien that further damages your credit score.
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