How Short Sales Affect a Credit Score

The phrase, “short sale” has quickly become a media darling and popular foreclosure avoidance tactic. In a nutshell, a short sale is a settlement agreement between a bank and a borrower to sell a home “short” of the mortgage balance, keeping the negative consequences of foreclosure off a consumer credit report. Of course, short sales don’t all come up roses; they have negative credit consequences all their own. As with anything else in life, there are pros and cons to this specific real estate solution.

Foreclosure vs. Short Sale

Post foreclosure, the initial impact to a credit score is a plummeting drop of at least 200 points. This negative consequence follows the borrower for at least seven years after the fact. While the devastating result of a foreclosure is undoubtedly a long lasting credit impairment, it doesn’t mean that a consumer cannot recover from it in less than seven years, depending on how he manages his credit moving forward. However, the road is long and treacherous.

In contrast, short sales don’t end up with as drastic as result. Instead of an immediate drop in a credit score of 200 points or more, short sales typically result in a credit score drop between 100 – 120 points; a far cry from a credit killer. Again, the negative consequence follows the consumer for seven years on his credit report, but the time for recovery remains in the consumer’s hands and with a brighter outlook than its distant cousin, foreclosure.

Default Judgments

If the credit score differential alone isn’t enough to convince you of the benefits of a short sale compared to foreclosure, the prospect of a default judgment might be the missing ingredient. A default judgment occurs when the lender sells the house post foreclosure for less than the mortgage balance, and is still able to pursue the borrower for the difference. For example, if a homeowner owed $200,000 on a home that the bank sold for $150,000, the lender could file a default judgment against the borrower for $50,000 with the county court. Once the lawsuit is filed and approved, a court order is issued against the consumer to remit payment; tailing him for 10 years. Default judgments affects a consumer’s ability to purchase a home, buy a car, or even secure a new credit card in the future and –in some states—comes with even more severe long term consequences, including wage garnishment.

However, short sales aren’t always automatically exempt from default judgments either, unless the homeowner negotiates terms with his lender and obtains guaranteed written acceptance from the bank stating they will not file a default judgment after the short sale is successfully concluded. Regardless, a homeowner has a much better chance of avoiding the maelstrom of a default judgment with a short sale compared to foreclosure in nearly every scenario.

Foreclosure has become the new “F” word in real estate, resulting in a dark cloud that hangs over your credit for many years after the fact. In severe contrast, a short sale is a “lesser crime” in the eyes of banks and lenders, making it a noteworthy and smart choice if keeping a home is no longer a viable option. Despite the negative consequences, short sales have miles more potential when it comes to speedy credit recovery than a foreclosure ever will.