As the economy slowly recovers the housing market is mending and short sales have become more frequent as homeowners scramble to avoid a foreclosure.
In the second quarter of last year, short sales made up 12% of nationwide home sales, according to RealtyTrac, and Bank of America (NYSE:BAC), the county’s largest servicer of home mortgages, said it expects to process more than 100,000 short sales this year. California has one of the highest rates of short sales in the nation and more than a quarter of all homes sold in the state in spring 2011 were through this process.
A short sale is when a mortgage holder seeks permission from the bank to sell the home for less than owed on the mortgage. Sometimes homeowners do this when they need to move and they owe more than the house is worth. Sometimes a short sale is an alternative to foreclosure – a gesture by owners to show the bank they’re willing to work recoup the loss. Banks are often open to working with homeowners because they generally lose more money on a foreclosure than a short sale.
Geography can play a role in the whether a short sale is approved. In Florida, for example, foreclosures are relatively fast and inexpensive for banks to process so they may not approve a short sale. In Arizona, banks are prohibited from selling a foreclosed home for more than the mortgage amount, giving the seller more leverage.
Short Sale = Settlement
Many homeowners believe a short sale on their house will have less negative impact on their credit score than a foreclosure. This is a common credit score myth. The impact of a short sale or a foreclosure on an individual’s credit score varies depending on the exact circumstances, but according to credit scoring company FICO, a short sale on a home has almost the same effect as a foreclosure.
Sellers can expect to see their credit scores drop anywhere from 85 to 160 points after process. However, people who opt for a short sale might drop fewer points and have an easier time buying another house in the future.
A lot of the impact on a credit score depends on how the bank reports the sale. Short sales are most often reported as settlements on a credit history, rather than as paid debts. The term “settled” on a credit report indicates that the lender accepted a lesser amount than was owed, and that always has a negative effect. Occasionally, a lender will agree to report a short sale as “paid,” which will not affect a credit score negatively – but this is rare and takes some tricky lender-borrower negotiation. The chances of this are greater if the homeowner never missed any payments, wrote a compelling hardship letter to the bank (a hardship letter spells out the reasons that the borrower is having trouble making payments), and had a good credit history to begin with.
Negative History, Positive Score
When it comes to short sales and credit scores, there is good news and bad news.
The good news is no matter the health of a credit score before the property deed was transferred, a short sale doesn’t have to a credit report forever.
The bad news is people who are considering short sales often already have damaged credit from other late payments, and the short sale will only drag that credit score further down. Lenders don’t tend to look kindly on borrowers whose credit scores are already in the subprime range – about 620 or less. A person with a low credit score may take a greater hit than someone whose credit was more healthy before the short sale.
If you are forced to sell your home through a short sale, here are three guidelines to get your credit back on track and get back on your financial feet quickly:
- Order a copy of your credit report. More than 80% of credit reports have mistakes, so order copies of your credit report from all three major credit bureaus – Experian, TransUnion, and Equifax. With a short sale on your report, you don’t need anything dragging your score down further. Common culprits that hurt credit scores are medical collections you never knew existed and debts owed by people with similar names. Look for tips on how to get a high score with credit reporting agencies.
- Be savvy about your existing accounts. Your length of credit history, on-time payments, a mix of loan types and debt-to credit ratio all play a part in your overall credit history. If you’ve still got credit accounts that are open, don’t close them, make payments on time, keep debt as low as possible, and try to keep accounts of different types open.
- Open a secured line of credit . If your credit is truly trashed and all your credit cards are maxed out or frozen, you can probably still get a secured credit card, which requires a deposit as collateral. With an opening deposit from $200 to $2,000, you can get a credit card that will report to credit bureaus and help you rehabilitate your credit score. Make small purchases that you can afford and over time you will see your score will rise.
Michael Germanovsky is a personal finance expert with in-depth knowledge of credit cards, charge cards, and pre-paid cards. His tenure as a personal finance expert began at the Novoye Russkoye Slovo, a partner of the New York Times International Weekly. In 2011, Germanovsky created the Student Credit Card Education Initiative and sounded awareness of high interest rates. At large, Michael is editor-in-chief at Credit-Land.com.