A short sale can hurt your credit scores because you’re settling your mortgage loan for less than you owe rather than repaying the full amount as agreed. As with other negative marks, the exact impact on your scores will vary depending on your overall credit history and the scoring model used to calculate your credit score. However, you can take steps to improve your credit and limit the long-term effect.
How Do Short Sales Work?
A short sale is when you sell a home for less than your outstanding mortgage balance. It’s a way to get out of a loan when you’re underwater (meaning you owe more than the home’s currently worth) and avoid foreclosure if you’re having trouble affording your payments.
Before you proceed with a short sale, you’ll need your lender’s approval. Often, lenders may agree when a borrower runs into financial trouble—such as a job loss or medical emergency—and the lender determines a short sale will be more favorable than foreclosing on the property.
If you’re approved, you’ll still need to go through the home-selling process, which can be more complicated than a normal sale because your lender will ultimately be the one to accept or decline a buyer’s offer. The timeline could also be drawn out if you have several lienholders (for instance, if you have a home equity loan or home equity line of credit), or if your lender sold your mortgage to an investor.
After a short sale, you may be responsible for the difference between the sale price and the outstanding balance unless you get a waiver of deficiency from the lender or live in a state that doesn’t allow deficiency judgments.
Does a Short Sale Show Up on Your Credit Report?
A short sale will show up on your credit report, but you might miss it if you don’t know what to look for. That’s because you won’t actually see the words “short sale.” Instead, your mortgage loan account will have special codes applied that label it as “settled” and “account legally paid in full for less than the full balance.”
Once your credit report is updated with this information, you may see your credit scores drop. Because payment history is one of the most important scoring categories, settling a debt may have a large negative impact.
Your exact point change will depend on the other information in your credit report, the scoring model and whether your lender reports a deficiency balance. When a deficiency balance is reported, the short sale might impact your credit scores like a foreclosure or deed in lieu of foreclosure would. Short sales without a reported deficiency balance could hurt your scores less than a foreclosure.
The overall impact on your scores may also be less if you didn’t miss payments before selling the home. In contrast, foreclosures are always preceded by late payments.
Credit scoring aside, a short sale can also be a better option than foreclosure because you won’t need to wait as long to qualify for an FHA loan if you want to buy another home.