How Short Sale v. Foreclosure Affects Credit Scores

A key issue for clients facing a short sale or foreclosure is how each affects their credit score. There are a number of factors that favor a short sale over foreclosure.

If the homeowner is participating in the federal government's Home Affordable Foreclosure Alternatives (HAFA) Program, there are definite credit benefits to choosing a short sale over foreclosure. Recent changes to the HAFA Program dictate what the lender can state on the borrower's credit report after a short sale, and lessens the impact on the borrower's credit rating. Credit bureau reporting of HAFA transactions where the deficiency is forgiven is now to be reported as "Paid or closed account/zero balance" or "Account paid in full/a foreclosure was started", as applicable.   A short sale is usually reported as “Account paid for less than the full balance”, or similar statements which have a negative affect on the homeowner's credit score.

While doing a short sale will negatively affect credit, short sales by their very nature may well have a lesser effect on credit than foreclosures. For instance, a completed foreclosure means the borrower has, at a very minimum, missed six months of payments (often considerably more). The property has also gone through a completed foreclosure sale. So while a short sale negatively impacts credit, the effect has been shown to be less than a full blown foreclosure which followed months, if not years, of missed payments.

Here are a few additional benefits of doing a short sale v. foreclosure:

• With a short sale, the homeowner is in control of the sale, not the bank. In fact, today cash incentives may be available to homeowners who decide to do a short sale instead of foreclosure.
• When the consumer wants to obtain a loan to purchase a property in the future, more opportunities will be available to them sooner if they do a short sale. For example, contrary to popular belief, one can be current on their payments and still do a short sale.  And if a homeowner is current on their mortgage through a short sale, they can qualify for an FHA loan afterwards without any waiting periods.  The same option is not available following a foreclosure.
• Some people feel there is a much stronger social stigma attached to foreclosure as compared to a short sale.

Every homeowner's situation is different, so we always recommend speaking with a real estate attorney who can offer advice on the legal and tax implications for each individual's circumstances.   Washington Property Solutions partners with a highly respected real estate tax attorney who can answer any financial questions your client may have and help them make the right decision. Call us at 425-381-2233 and we can refer you for a consultation.