Short Sale’s Effect on Credit

There are people who say that a short sale does not have a derogatory effect on your credit. I disagree. I have minimized the effect for some of my clients and on rare occasions convinced the bank to report the sale as “paid as agreed”.  That is extremely rare.  Normally, a short sale is reported as “paid for less than full value”.  That is a substantial ding on the seller’s credit. 

My friend George Durkin from Las Vegas is a great student of short sales.  He sent me an article from About.com that argues that a short sale is not much different than a foreclosure as far as a future lender is concerned, because both show that the borrower did not pay the loan fully.  It argues that the next banker will look at the short sale on the credit report and say “that the defaulting homeowner is someone who, when the chips are down, didn’t honor a contract.”   I disagree with that also, and I think George does too, but he knows I want to read everthing on short sales.

While the effect of a short sale on a credit report is not good, it is not as bad as some of the other choices.  The simplest proof is to look at the Fannie Mae guidelines for loans.  The guidelines state  that the “seasoning” on a foreclosure is at least 5 years, the “seasoning” on a deed in lieu of foreclosure is 4 years, while the “seasoning” on a short sale is 2 years.   In other words, it will take five years if you are lucky after a foreclosure to qualify for top quality financing, four years after a deed in lieu of foreclosure to the the best loans,  while it takes two years to get back into good graces after a short sale.   There are some restrictions that apply to people with foreclosures that extend from the fifth year after the sale to seven years after the sale, such as Fannie Mae will not finance a second home during that period.  There are no such restrictions to people who have done a short sale.  

 Secondly, on a loan application the borrower will have to answer the questions in the Declarations Section VIII  “have you had property foreclosed upon or given title or a deed in lieu thereof within the last 7 years?  (y/n)”  The next question is “have you directly or indirectly been obligated on any loan which resulted in foreclosure, transfer of title in lieu of foreclosure,  or judgment? (y/n)”  If you have had a foreclosure or given a deed in lieu of foreclosure, you answer yes.  If you have had a short sale, you answer no.

Some commentators state that a foreclosure will cause a 250 point decline in your FICO score while a short sale will cause a 100 point decrease in the FICO score.   I do not believe you can measure it that precisely, as credit reports have many factors that are considered simultaneously.    Others say the range is from a 50 point decline on the low side to a 350 point decline on the high side, depending on what your score was before the short sale.  The short sale will drop of the credit scoring system after 7 years, which is normal for a derogatory item on a credit report.

On one hand some lenders argue that there is no credit preservation advantage of a short sale, and on the other hand there are those short sale commnetators who say a short sale has no effect on your credit.  Both extremes are not supported by the facts.  Like most other things in life, reality is somewhere in the middle:  there will be credit damage from a short sale, but it is better than the alternatives.