Mortgage match-up: “Foreclosure vs. short sale on your credit report.”
It’s been a while since I’ve come up with a mortgage match-up, but there’s been a lot of fuss about short sales and credit scores lately, so I wanted to add my two cents.
I already touched upon how a foreclosure affects one’s credit, but I never really addressed the impact of a short sale.
Let’s start with short sales, which have surged in popularity, and then tie in foreclosures at the end to illustrate the difference.
A Short Sale Will Lower Your Credit Score
- Even if you strike a deal with your lender
- To sell your home for less than the mortgage balance
- It will still be reported to the credit bureaus
- As a negative event and lower your score
Despite what you may think, or what you have may heard, a short sale is a still a negative event, according to FICO, the founder of the FICO score.
Why? Well, with a short sale, you are essentially making a deal with your creditor to pay less than what is agreed. This is the essence of a short sale.
And when you pay less than what is agreed, there’s a possibility that the lender can pursue a deficiency judgment against you.
But in the case of a short sale, you are essentially protecting yourself from any negative repercussions on that front by getting the lender to call the debt “paid,” even if for less than agreed.
That’s all good and well, but because it’s paid for less than what is due, your FICO score will drop.
The million-dollar question is by how much, and will it be worse than foreclosure?
Like all things credit, it depends on your situation. Sigh…
Similar to a foreclosure, if you’ve already got negative items on your credit history, the impact will be less substantial.
But if you have pristine credit going into the short sale, expect a more precipitous drop.
It’s impossible to say your credit score will fall “X” points after a short sale, but you can get a better idea depending on the circumstances of your short sale.
For example, if you’ve never been late prior to the short sale, it will mean you don’t have any associated mortgage lates.
This is a good thing because you won’t have a series of seriously delinquent mortgage payments on your credit report.
That should lessen the impact of the short sale, but as noted, it can still be substantial, especially if you’re perfect otherwise.
Short Sales Treated the Same as Foreclosures
- While both events are treated the same by FICO
- There may be major differences in consumer behavior
- Such as no late payments leading up to the short sale
- Whereas the foreclosure will definitely have late payments
So what about foreclosures? Well, back in the day, FICO said they look at foreclosures the same as short sales. For the record, deeds-in-lieu of foreclosure are treated the same too.
Of course, they’re probably just talking about the actual event, when the mortgage is charged-off for less than what is actually due.
The glaring difference with a foreclosure is that there are a series of late payments that lead up to the event.
With a short sale, there may not be a single late payment. So right there, we’ve got a major disparity.
Even though FICO looks at the final event the same, a short sale may be contained to one negative event, whereas a foreclosure will be preceded by lots of negative events.
This explains why a foreclosure may lower a credit score much more than a short sale.
It Goes Beyond Your Credit Score
- The credit score impact is just one of many issues
- You also have to consider tax implications
- A possible deficiency judgement
- And the ability to get another mortgage in the future
Of course, FICO only addresses the impact of a foreclosure or short sale on your credit.
But that’s not the end of the story. The presence of a foreclosure can also lead to a deficiency judgment, meaning the lender can come after you for the unpaid debt in some cases in certain states.
And Uncle Sam may come after you for any forgiven debt as a potential tax liability.
So you’ve got to consider those aspects as well when deciding between a short sale and a foreclosure.
On top of that, there are also certain rules when it comes to getting a mortgage after a short sale or foreclosure.
[How long after foreclosure can I purchase a home?]
Generally, there is a shorter waiting period if it was just a short sale as opposed to full-blown foreclosure.
In other words, there is plenty to consider here beyond your credit scores. In either case, try to work with your lender to lessen the blow, and always get everything in writing when negotiating!
You are correct that a lender can seek a ” deficiency judgment ” between the amount owed and that collected at settlement, so the mortgage debt is not technically ” paid.” The bigger problem you do not comment on is the right of IRS, in lieu of the lender seeking a deficiency judgment ( Not likely as US lender’s presently hold 12M in mortgages, post Trustee/Auction sale, i.e. empty homes with no monthly income stream ) is that IRS will send the homeowner or taxpayer a 1099 for ” income gain ” which is actually the loss plus fees and penalties. Federal tax liability based on tax bracket.
Good point Tony. This post is more about the credit scoring impact of a short sale or foreclosure. But your comment does reveal the complexities of the decision. One should probably consult with a CPA/lawyer to determine all the potential outcomes and consequences.
Great post. It’s important that readers understand both the credit score impact of each, along with other repercussions, such as the waiting period to get another mortgage.