Lesson#5 - How Does a Short Sale Affect A Credit Score?

The #1 question my students are asked by homeowners is, How does a short sale affect my credit score?  Let’s define what a credit score is first before we embark on how  a short sale affects your score.   Your credit score is actually a formula developed and maintained by a private company called Fair Isaac Company, Inc.  The score is determined on a weighted scale with Payment History and Amounts Owed weighted far heavier than Length of Credit History, New Credit and Types of Credit Used.  See FICO Basics for a more detailed explanation. 

Since Fair Isaac invented and continues to maintain the credit score formula, naturally, we should ask them how a short sale affects a credit score.  The question posed to MyFICO.com was, “How does a foreclosure or short sale affect my score?”  Their response was:

“Credit bureau reports are limited in how they represent foreclosures today, so its generally not possible to tell from the credit report if a reported foreclosure is a short sale, deed in lieu of foreclosure, settled account, regular foreclosure or some other variation.  The FICO score treats all of these descriptions that appear on credit reports as serious delinquencies, so they have an impact on the score similar to the impact from a charge off, tax lien or account included in bankruptcy.”

Not what you were hoping for, huh?  Well, in another article I put together, “Why a Short Sale is Better Than a Foreclosure“, I describe the massive benefits of a short sale over letting the property go to foreclosure.  As it turns out, the credit score itself is not necessarily helped by a short sale over any other seriously delinquent account, such as a foreclosure.  So the initial score decrease will be the same — experts say a ballpark of 100-200 points on a scale of 300 to 850.  And the higher the credit score the greater the fall.

But the report itself looks far better, being that most underwriters agree that a short sale looks better on a report than a foreclosure.  When you’re doing a short sale it shows that you’ve actually done something about the foreclosure, versus letting it go to foreclosure. In fact, FHA has developed a loan program just for borrowers who have had a short sale. 

Also, there is one way to minimize your credit score reduction when dealing with a short sale.  Try to avoid allowing the payments to go behind.  That maybe easier said than done and  I know that sounds like an oxy-moron, doing a short sale while keeping the payments current, but it can be done.  My students and I do those all the time.  The most destructive item to your credit score is the late payments.  When it shows 30 days late, then 60, then 90 then 120+ days late, that’s when the credit score takes it’s biggest hit.  So if you can squeek by and keep the payments from falling 30 days late, you stand to really minimize the damage to your score from a short sale. 

This answers the question of How does a short sale affect my credit score?