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Chapter 5: Credit Implications of Short Sales for Sellers (full)

It's important for homeowners to be aware of the credit implications of short salesBefore a homeowner decides to sell their home as a short sale, it is important to consider the credit implications of this option. A consumer’s credit report and credit score may dictate the interest rates offered on loans and credit cards, being hired for a job or even the type of home that an individual can purchase.

Today’s world is becoming increasingly credit-dependent, so sellers must carefully weigh their options and how those options will affect their credit before making the final decision. To help sellers make the right choice, the following is a guide to the credit implications of going through the shortsale process.

How Short Sales are Reported

A short sale will affect a seller’s credit report, so it is essential to understand how short sales are supported. Shortsales do appear on credit reports for some time. In most cases, they will be noted on a borrower’s credit report for five to seven years. However, the exact wording of this report can vary, depending on your lender.

Certain lenders report the mortgage loan as being “paid settled.” This is one of the smallest credit implications of a short sale and will do the least damage to your credit. Some lenders will report the mortgage as being “unrated,” which is not optimal, but it will not do as much damage to your credit as a foreclosure.

In other cases, lenders may report that the mortgage was a “pre-foreclosure in redemption.” This can occur if the home was already at risk for a foreclosure when the sale was closed. It is this wording on your credit report that may be viewed in a more negative light by lenders in the future. If this is the wording used, it is nearly as bad as a foreclosure going on a seller’s credit report.

Shortsales and Credit Scores

Being late on payments can lead to a credit score reduction.Not only will there be credit implications to consider on a borrower’s credit report, but one of the most drastic short sale credit implications to consider is the effect it can have on a seller’s credit score. The actual amount a shortsale will reduce an individual’s credit score can vary from 30 points to 300 points. However, a reduction of 200 points is about average for this transaction.

Of course, the short sale itself is only part of the reduction a seller may see on their credit score. What actually can lead to the largest drop in a score are the payments that may have been missed, rather than the actual shortsale transaction. The late or missed payments can lead to an additional drop in a seller’s credit score, depending on the delinquency of the payments.

Being 30 days late on payments can lead to a credit score reduction ranging between 40-110 points. Payments that were 90 days late or later will result in a further deduction of 70 points to 135 points. Keep in mind, the reduction in score due to late or missed payments is added on to the reduction in score due to the actual short sale. With serious payment delinquencies, the short sale can lead to more than a 400 point credit score drop in extreme cases.

How a Shortsale Affects Future Loan Applications

Borrowers should also be concerned about the credit implications of short sales because this transaction can affect future loan applications. The time a homeowner must wait to invest in a new home will vary. Under FHA regulations, sellers will need to wait a minimum of two years before they can apply for another mortgage. However, other loans allow consumers to apply for a mortgage right after going through a short sale.

Of course, while individuals may be able to apply right away, the credit damage that occurs may make it nearly impossible to get reasonable rates on a new home mortgage. In most cases, it is best to wait until there has been a sufficient recovery in credit score before applying for a new mortgage. In this way, individuals have a better chance of being offered comfortable mortgage terms.

Since short sales can have very serious credit implications, sellers should take measures to try to reduce the impact of these implications on their credit.Since short sales can have very serious credit implications, sellers should take measures to try to reduce the impact of these implications on their credit. The following are a few tips that may help.

Tip #1 – Work to Raise Credit Scores Before the Short Sale

First, sellers can work to raise credit scores before the short sale process takes place to help reduce the implications of this transaction. Spend time learning how to increase the credit score and work to use this information wisely. Sellers can project the potential damage to their credit score and target to raise their score by that amount before the sale. For example, if the transaction may lower one’s credit score by 200 points, working to raise that score by 200 points before going through with a short sale may help.

Tip #2 – Work to Continue Making Payments

Another helpful tip that may help sellers reduce the credit implications of a shortsale is working to continue making payments on the mortgage even while working towards a short sale. Homeowners do not have to stop making payments to get a lender to agree to a shortsale. Avoiding missed payments will help sellers avoid the extra hit on their credit score, which can make a big difference after dealing with the drop in credit score that occurs after the short sale takes place.

Tip #3 – Talk to Lenders About How the Shortsale Will Be Reported

Lastly, homeowners may also want to talk to lenders about how the shortsale will be reported on their credit report. Negotiate to make sure lenders report the sale in the least damaging terms possible. While the short sale will still go on the credit report, less damaging terms can make a huge difference in how future lenders view consumers when they apply for new credit.

Next: Chapter 6: The Mortgage Forgiveness Debt Relief Art of 2007