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A short sale of your home can help your credit rating by keeping a foreclosure off of it. But there are pitfalls. It is important to understand how short sales work, how your credit rating works and what scenarios can make a short sale beneficial or detrimental for you.
How A Short Sale Works
If a homeowner falls behind on mortgage payments, the lender can declare the borrower in default and force a foreclosure, which means legally taking the home from the homeowner and selling it at auction.
In a short sale, a borrower approaches a lender with an alternative to foreclosure. It is assumed the borrower is behind in mortgage payments and will be unable to get ahead. A job loss could cause this, as an example. The borrower and lender then agree to appraise the house and sell it, applying the proceeds of the sale to the mortgage.
How Your Credit Rating Works
Anyone who borrowers from a legitimate commercial lender has the loan and payment history reported to the three primary U.S. credit reporting bureaus. These are called Experian, Equifax and TransUnion.
Your credit history is an ongoing record of your borrowing and payment history, including any negative information such as late payments, charge offs, defaults, foreclosures and bankruptcies.
Your credit score, or credit rating, is calculated by the Fair Isaac Corp. based largely on your credit history.
Ending Negatives on Your Credit History
The first positive impact of a successful short sale on your credit history is that it ends the negative effects of missed payments. A lender will not consider you for a short sale if you are current on your loan, so it is assumed you already have late payments when you request the short sale. These late payments are showing up on your credit report monthly, lowering your credit rating. Negative information remains on your credit history for three years.
Avoiding Foreclosure
The second and more important way a short sale can help your credit rating is by avoiding foreclosure. A short sale is a sale of your home, and it does not show up on your credit report. The loan simply appears as paid off.
On the other hand, if your lender forces you into foreclosure because you are in default on your mortgage, the default shows up as a negative on your report and stays there for three years, and the foreclosure is added to your report and stays there for seven years.
To measure this impact, consider that the median credit score in the U.S. is 720. A score of 620 means you are a subprime borrower. A foreclosure can immediately knock about 35 percent off your credit score, so the impact is severe, and the benefits of a successful short sale are large.
Seller Beware
A short sale is not a guaranteed salvation for your credit score. The short sale will be approved for an offer of about 90 percent of the home’s appraised value. But that likely will not cover the entire amount of your outstanding mortgage. Most lenders accept the sale proceeds as paying your mortgage in full, but they are not required to. Even with a successful short sale, you could still be liable for the portion of your mortgage not covered by the sale.
