How a Short Sale or Foreclosure Affects Credit Rating

credit ratingI frequently get asked how a short sale or a foreclosure will affect a person’s credit rating.

Although the true impact a short sale will have on your credit score will depend upon how it is reported to the credit bureaus, there are a few general guidelines which apply.

A foreclosure generally has a more severe impact on your credit rating than a short sale.

A short sale is like a “D-” grade while a foreclosure is an “F” grade, or a fail.

More importantly, a short sale is often preferable to a foreclosure because of other negative legal and tax consequences involved in foreclosure.

Late Mortage Payments Affect Rating

Usually, people who complete a short sale are at least 2 or 3 months behind on their mortgage payments. The late mortgage payments will have a negative impact on the borrower’s credit rating in addition to the short sale itself.

So it’s not just the short sale itself, but the history of late payments leading up to the sale that affects the person’s credit rating.

When you do a short sale, your mortgage lender may report the short sale to the three credit bureaus in different ways.

The most favorable way of reporting the short sale is if the mortgage lender reports that the account was “Paid,” which is equivalent to you paying off the account in full.

However, unless you only had a small amount of debt to forgive, most lenders will report the short sale as “Settled” to the credit bureaus. A “Settled” account is equivalent to a 30-60 day late payment in most cases, and can put the homeowner in a position to purchase a new home as soon as two years later.

The worst means of reporting a short sale from a credit rating standpoint is if a bank lists the short sale as “Closed but not paid in full.” This designation could have dramatically devastating credit repercussions for as long as seven years, or as many as ten.

If a borrower’s goal is to repair their credit so that they can buy another house in the future, then this particular language could severely jeopardize the borrower’s chances of buying a home for as long as they would with a foreclosure.

Sign Up for Credit Monitoring Service

I often recommend that people who do short sales sign up for a credit report monitoring service for 6-12 months after a short sale.

Trust me, this is money well spent. These services will send you alerts whenever a report is made on your account.

If there is an incorrect report to the credit bureaus, you will know about it immediately and be able to jump into action to try to get the reporting party to remove the report.

Without the reporting service, it could be months or years before you discover the mistake and by then the damage is done.

I have had clients who have been alerted by their credit monitoring service that their former lender reported their short sale as “closed but not paid in full” even though the client had specifically negotiated for the lender to report the short sale as “settled.”

There are numerous companies that provide credit report monitoring. I have recommended TrueCredit.com to many of my clients (affiliate link), which a service run by TransUnion, one of the three major credit bureaus. TrueCredit.com offers a free credit score and a free 30-day trial. For $9.95/month, you get unlimited access to your 3 credit scores, 24-hour notification of critical changes to all three reports.

The bottom line is it’s really not possible to paint a complete picture of how a short sale will affect a credit rating years into the future, because we don’t know what lending standards will be in the future.

On the one hand, banks may view this time period as an anomaly, when many otherwise creditworthy homeowners got caught up in a bad recession and had to do a short sale or had a foreclosure.

On the other hand, banks may continue their rigid lending practices in place today for many years in the future, still licking their wounds from the mortgage meltdown.  Only time will tell.

 

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Photo credit: Flickr/rinkjustice


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