How Does a Short Sale Affect My Credit Score?

How does a short sale affect my credit score? This is one of the most common questions we have received from homeowners in recent months. It's also an area of common confusion and misinformation. So we thought it was time to set the record straight. This article explains how the short sale could affect your credit score, and how it might impact you in the future.

The housing crash of 2008 - 2009 caused home values to plummet all across the country. The so-called "sand states" were especially hard hit: California, Florida, Arizona and Nevada. This put a lot of people upside down in their mortgage loans, meaning that they owe more on their loans then their homes are currently worth. This makes selling the home much more difficult, and it accounts for the rising popularity of the short sale method.

But what is a short sale, exactly, and how will it affect your credit score? Let's take a closer look.

The Short Sale Defined

Let's start with a quick definition of the short sale, just so we are on the same page. Then we can talk about the credit aspects of it. A real estate short sale is when you sell your house for less than what you owe to your lender. You must have your lender's permission to pursue this kind of selling strategy, because they must agree to accept less than the full balance.

For example, let's say I still owe $150,000 on my home loan. But depreciation has lowered the value of my house. It's only worth $110,000 in the current market. If I want to sell my house, I basically have two options:

  • I can pony up the $40,000 difference to pay off the lender, or...
  • I can ask the lender to accept  $110,000 and call it even. This means the lender will eat the $40,000 loss and consider the mortgage loan paid off completely. This is a short sale.

In essence, a short sale is a form of debt settlement. You are entering a debt-related agreement with the lender, in which they agree to settle for less than the full amount owed. This is an important point, because a short sale may actually show up on your credit report as a debt settlement or charge-off. And that brings us to the point of this article. 

How it Affects Your Credit Score

There's a common "myth" that says the short sale won't affect your credit score, because it never really shows up on your credit report. I put "myth" in quotation marks, because this is actually true and false at the same time. The actual words short sale may not show up on your credit report, because there is currently no credit-reporting category that includes that phrase. But the event itself can still show up -- it will just be labeled as something else.

So yes, it can certainly hurt your credit score. It can do just as much damage as a debt settlement or charge-off, because it's often reported in one of those categories. But it may do less damage than a foreclosure.

In some cases, the lender may report the debt "paid in full" and simply forgive the remaining amount owed. These situations are rare, but they do occur. In this scenario, the short sale would not affect the borrower's credit score. It all comes down to how the lender handles the reporting side of things.

If you are delinquent on your mortgage, then your credit score has already taken a hit. Most lenders start reporting missed payments when they are more than 30 days past due. This will do serious damage to your credit score, perhaps 100 points or more.

On the other hand, if you are current on the loan going into the short sale, then your score will not suffer as much. It will only be affected by the short sale reporting -- but no late payments.

According to Maxine Sweet, the public education director for the Experian credit bureau: "Anytime you fail to repay a debt in full it will negatively impact your credit report, even if the account was never late before the debt was settled through a short sale."

This much we know. But the one thing we cannot say is how much your credit score will suffer. This depends on a variety of factors, including the lender's reporting code and the rest of your credit-report situation.

Lesson Summary

The number of short sales has skyrocketed in recent years, mostly as a result of declining property values. Many homeowners are now upside in their loans, meaning they owe more than the home is worth. The short sale strategy is often used in these circumstances, because it allows the homeowner to sell for less than they owe on their mortgages.

The actual words "short sale" may not show up on your credit report, because there is currently no reporting code that uses those words. But it can still be reported. Many lenders report it as a debt settlement or a charge-off, which indicates that the account was not paid in full. As a result of this reporting, the short sale can affect your credit score in a negative way. The amount of damage depends on your overall credit picture, and the reporting code used by the lender.