If you're upside down on your mortgage, or just looking for a way to cut your losses on your depreciating home value, you might be considering a short sale. Make no mistake, your credit will take a hit if you go this road; however, it might not be as bad as you think. Prolonged delinquency on payments, bankruptcy, and foreclosure will likely harm your credit more, so getting ahead of the game with a short sale might be to your advantage when it comes to salvaging credit.
Defining the Short Sale
A short sale is essentially an agreement between you and the bank to take a lesser sum for your house than it's currently worth. Of course, reaching this agreement requires some legwork on your part, and the help of a savvy short-sale Realtor. Short sale terms -- and outcomes -- vary widely, depending on your financial situation and lender. If you're behind with payments and on the path to foreclosure, your bank might be more inclined to work with you. That way, they get at least some of the money owed them on the loan. There are also such things as strategic foreclosures. In this scenario, a homeowner may be able to afford his monthly payments, but wants to cut his losses on his depreciating asset.
Your Credit History
What happens to your credit rating after a short sale is significantly impacted by what your credit history was before it occurred. That means, if you're entering into a short sale due to late or no payments on your previous mortgage, maxed-out credit cards, or other credit-risky behavior, you've likely already taken a hit on your FICO score.
The Damage Report
According to myfico.com, short sales and foreclosures are viewed similarly, with respect to influencing your credit score. It is the way these delinquencies are reported by lenders on credit reports, and other outstanding factors, that influence scoring. Generally speaking, short sales are reported as "settled" accounts on your credit report -- meaning you reached an agreement with the bank to pay only part of the debt.
A 2009 FICO report assessing "damage points" indicated that debt settlements could subtract as much as 125 points from a FICO score of 780. A lower FICO score of 680 would be more moderately affected, with a drop of 45 to 65 points. Sometimes, however, a lender may not cancel the debt owed, and will hold you accountable for the remaining balance. This will appear as an outstanding debt on your credit report. This scenario can be just as damaging as a foreclosure, if it causes liens and judgments against you because you are unable to settle the debt.
Weighing the Risks
While a short sale will negatively impact your credit score, it won't last long. Credit expert Linda Ferrari says major lenders generally require a wait of two years before you can apply for a new mortgage. In the meantime, you can build your savings, repay debts, and clean up other issues that may have also adversely affected your score. A short sale may feel like a big risk, but it can be an attractive alternative to foreclosures or bankruptcy filings, which leave a black mark on your credit for seven to 10 years. Remember: More than one-third of your FICO score is based on payment history, which includes all delinquencies. So consider your entire credit history leading up to the short sale process, to accurately assess the impact of a short sale.
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