Wanda Wilkinson

As we have seen and heard on the news, due to predatory lending of years past and a decline in housing values, more and more people are finding themselves stuck in a position where they owe more money on their mortgage than their home is worth.  Many of these same people may be facing the decision of a Foreclosure or Short-Sale.  While the decision of what to do is different for individual circumstances, one thing should not be overlooked…the effect that each will have on credit.
 

Everyone knows that a Foreclosure will have a negative impact on credit and credit scores, but there seems to be a lot of misconceptions about the impact of a Short-Sale.  The honest answer is they both damage credit scores nearly the same.  Here’s the reason:  A Short-Sale is a settlement due to the fact that they didn’t fully pay the loan as agreed in the original terms or contract for the loan yet the balance is now $0. When there is a Short-Sale, the mortgage lender will report the account as “settled” or “paid for less than the full loan amount”.  The exact terminology may vary slightly but they all mean the same thing: even though the loan is reported with a $0 balance, the account was not paid in full according to the original terms of the loan agreement. Credit scoring models consider “settlements” as severely negative indicators. Therefore, Short-Sales can be just as bad as Foreclosures when it comes to credit and credit scores.
 

This article is not intended to offer legal advice about which is a better option (Foreclosure vs. Short-Sale), merely to clear up any mis-information you have heard about each.  Below is information provided by the Certified Distressed Property Expert (CDPE) training.
 

 

 

I am using this information only as an example, although it is not the only place where similar information can be found.  Needless to say, this information is inaccurate and may be a major cause for many of the misconceptions floating around.  First of all, the effect that a Foreclosure can have on credit scores is almost impossible to determine unless you work for FICO (formerly Fair Isaac, Co).  One thing for certain though, the higher a person’s credit scores are, the bigger the negative impact.  This is due to the fact that a person with lower credit scores already reflects riskier credit behavior.  Second, a Foreclosure of Mortgage does not show up under the Public Records section of a credit report.  The only reporting of a Foreclosure would be done by the mortgage lender including a narrative stating “Foreclosure Initiated” or “Foreclosure” and would only be reported for 7 years.
 

Similarly for a Short-Sale, a mortgage lender will report a narrative stating “settled” or “paid in full for less than the full loan amount”.  This will have nearly the same negative impact as a Foreclosure and will also be reported for 7 years.