Short Sale and Credit Score

The real estate climate in today’s economy is one of the most difficult times to sell a home. It was recently estimated by the Wall Street Journal that one in four Americans is currently underwater on their mortgage. This means that at the present time, these homeowners cannot sell their house for enough money to fully pay off the mortgage. Unfortunately, there are very few indicators that the real estate market will improve soon, and the economic conditions in many of the most affected areas are forcing many homeowners to move for jobs.

This means that many homeowners have no other choice but to sell their house for less than they owe on it. Since very few people have the money to make up the difference, this means that many people will opt for a short sale. In a short sale, the bank which holds the mortgage agrees to accept the amount that the house sells for in lieu of full payment on the mortgage. The homeowner does not owe the bank any money at closing, but a short sale does have some serious implications on the seller’s credit score.

A short sale will typically “cost” a seller a steep dive in his or her credit score.  American consumers actually have three credit scores, each of which is determined by a separate company with a different method of calculation.  The exact formulas are a very closely guarded secret, but most people who have been through the short sale process have seen a drop between 150 and 200 points. For consumers with good credit scores (usually defined as above 720), this means having a score in the low 500s, the level typically considered by most lenders to be “subprime”.

Having a short sale on their credit record means that most consumers will not be able to purchase another house for at least two years after the short sale has been approved. Note that this is the minimum amount of time that has been reported by consumers; many banks are still publicly stating that consumers will need to wait five years before being able to qualify for another mortgage. 

Nonetheless, a short sale is still a better option than a foreclosure or a bankruptcy, both of which will affect a credit score for up to seven years. It should also be noted that after six months, many consumers are reporting that their credit score starts to rise again. This is because “bad” incidents on credit reports have less of an effect on a consumer’s credit score as the incident becomes further in the past and better incidents get reported.

Short sales can be temporarily devastating to a credit score, but it is certainly possible to recover from one. Many consumers who sold their homes through short sale in 2008 are now able to buy another home, and have almost completed the process of repairing their credit. If you are underwater on your mortgage and have to move, you may want to carefully consider this option.