A distressed homeowner has many ways to sign away the ownership of his house and short sale has been a hot buzz in the real estate market for over a decade. Many people use short sale as an option to avoid foreclosure and get rid of the upside down . In a short sale, the lender allows you to sell the house for less than what you owe them. The deficiency (difference between debt owed and price of short sale) is generally forgiven by the lender or, if you have assets, the bank will require you to pay the shorted difference by selling off your personal assets.

However, the United States is not a fairy tale land, so short sale is not as easy as it seems in this country. Before anything else, you have to qualify for a short sale. The qualifications? You must be in financial trouble like unemployment, medical emergency, death or bankruptcy; you must have defaulted on payments or you are on the verge of default, you have no assets to sell off and pay the debt.

If you are fortunate enough (or ruined enough?) to get qualified, you have to submit all your financial records including hardship letter, tax returns, proof of assets and annual income to assure the lenders that you are really in a big trouble. When the buyer purchases your house with consent of the creditor, you think everything is past now. But that past is going to trouble you for years to come, simply because it badly lowers your credit score which has become necessary for everything from job application to purchasing cars or financing a new house.

How Does Short Sale Affect Your Credit Score?

A popular misconception in our society is that short sale is less damaging to the credit score than foreclosure, therefore we interpret short sale as being less offensive. However, lending experts and Fair Isaac do not differentiate between short sale and foreclosure or deed-in-lieu. They all generally lower your credit score by 85 to 160 points.

What makes the fall more drastic is your degree of delinquency on payments before the derogatory event took place. If you stay current on payments or just slightly delinquent, expect the damage to be minimal on your credit score. Every time you miss a payment, the more negative impact on your credit score will be, no matter whether your house is foreclosed or sold in a short sale. Practically, if your payment is 120 days past due, even short sale is automatically displayed as foreclosure on your credit report.

How Can You Minimize the Impact on Your Credit Score?

Though completely avoiding the downfall is next to impossible, there are certain ways you can minimize the impact of short sale.

1- Negotiate with your lender for short sale when you foresee a possibility of default on mortgage payments in the coming months. Be proactive to find a buyer and contact the lender regarding the issue well before you miss the payments. Without a buyer, lenders are highly unlikely to entertain your proposal.

2- Credit bureaus evaluate your case based on how the lender or bank reports the short sale. So, negotiate with the lender to report it as “settled as agreed” or “paid in full.” It will lower your score by only 85-160 points.

Pros and Cons of Short Sale

Despite knowing that there is no basic difference between foreclosure and short sale as far as impact on credit score is concerned, why do people still prefer to go for a short sale? And if you happen to be one of them, you must know various pros and cons of short sale.

Pros

1- An escape from foreclosure. Foreclosure is a tedious and stressful process for the homeowner as well as the lender. The public announcements, events and auction notice on the front door of house, all drag your sense of pride and name to the streets. Nothing could be more embarrassing. Lenders have to pay for various costs without any surety that the auctions will fetch at least the invested amount.

2- In a short sale, you need not pay the transfer taxes, commission, sales fee, etc. that often adds up to 8% of the selling price. It all is paid by either buyer or the lender. More importantly, you are blessed with the right to negotiate with creditor and buyer on who pays for what and how the lender will report to credit bureaus.

3- The two largest mortgage investors in the United States – Fannie Mae and Freddie Mac – restrict themselves from lending you only for two years if you opt for short sale. A homeowner who suffers foreclosure cannot borrow for five years. That is, with a short sale you can re-qualify for a new loan to own a new house much sooner.

4- When your credit report shows a foreclosure, you’ll face trouble getting a loan from credit cards or to finance a car, etc. whereas people look favorably at short sale. There exists a disgrace for foreclosure in our society, which is not the case with short sale.

5- Creditor can forgive the difference between debt and selling price.

Cons

1- You have no guarantee that the creditor will approve your proposal for short sale. Everything remains uncertain until approval, and banks are notorious for not approving the short sale to the point it becomes only option except foreclosure.

2- If you have some property, jewelry or bank balance, the lenders are unlikely to forgive the loss (difference between debt owed and selling price). In that case, they can force you to compensate for the loss by selling your personal property.

3- Even if the bank somehow forgives the loss, it may issue a 1099 for the forgiven amount, which is sent to IRS. According to IRS, the forgiven amount is a taxable income so you have to pay taxes on that amount.

4- Short sale is absolutely not a short process. It consumes a lot of time to put together all the papers, financial proofs and other documents. The lender scrutinizes everything before giving a nod.

Short sale affects your FICO score as much as a foreclosure. The further fall in your credit score depends on how punctual you have been on your payments. It has its own pros and cons, and the process involves many details that an average homeowner is unaware of, so you are advised to consult a professional having successful track record with short sale.

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H & I Credit Solutions