If you are having trouble making your mortgage payments, you may wonder if you are going to face foreclosure. You may even contemplate entering into a short sale agreement with your lender. Either way, you lose your home, but does one process affect your credit less than the other?
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We help you understand the implications of both the short sale and foreclosure below.
What is a Short Sale?
First, let’s look at what a short sale is and how it works. If you know you
can’t make your payments any longer, you may contact your lender and ask for a short sale. This means the lender is willing to accept less than the outstanding balance of the mortgage, yet consider it paid-in-full. This option is often open only to borrowers that are behind on their payments. It saves the lender from having to take possession of the home in a foreclosure, while taking somewhat of a loss on the home.
How Short Sales Affect Your Credit
Assuming you get a lender to approve your short sale, you should know how it affects your credit. While there’s no formula that will determine exactly how much your credit score is affected, we do know the factors that affect it:
- How late are your mortgage payments? Some lenders allow you to enter into a short sale even without making a late payment. If you know you can’t make the payments or you have to sell the home due to a job relocation but have no equity, a lender may approve the short sale. If you never made a late mortgage payment, your credit may not be affected. If, on the other hand, you have late payments, every 30 days the
payment is late the more points you lose on your credit score.
- Is the lender considering the loan paid in full? How the lender reports the settlement will also affect your credit score. If they report it as ‘paid in full,’ it won’t hurt your credit score very much. If they report it ‘settled for less’ or ‘not paid as agreed,’ your credit score may drop more since that shows financial irresponsibility.
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What is a Foreclosure?
A foreclosure is something the lender initiates, rather than the homeowner initiating the process. If the lender starts foreclosure proceedings, it means you were at least 90 days past due on your mortgage and you didn’t take any steps to rectify the situation.
The lender will start with pre-foreclosure proceedings, which basically let you know that the home is about to go into foreclosure and you will need to leave the home. You may not deal with the bank as much as you deal with the trustee or even the county sheriff as the bank takes possession of your home.
How a Foreclosure Affects Your Credit
Because you have to be late on your mortgage in order for the lender to start foreclosure proceedings, it’s safe to say that your credit is sorely affected. Your credit score will start dropping when your mortgage payment is more than 30 days late. If you then hit 60 or 90 days late, it drops even further. On average, you can see a credit score drop as much as 100 points just from missing three mortgage payments.
On top of the decrease your credit score took from the late payments, you’ll also have the repercussions of the actual foreclosure. You may see your credit score drop another 75 to 100 points once the foreclosure process is done.
So how do you tell which is better for you – a short sale or foreclosure? It really depends on your situation. Do you plan to buy another home in the future when you are back on your feet? You may want to consider the short sale, then, as it often has a shorter waiting period to get a new loan. If your lender won’t agree to a short sale or you are so far behind on your payments that foreclosure is the only option, though, you may not have a choice.
Either way, the important thing is that you pick up the pieces and move forward. Start
establishing your credit again as soon as possible. Apply for secured credit cards or even department store credit cards. Charge what you need and can pay off right away. Then make sure you pay the balance off to establish your credit. As your credit score improves, apply for other forms of credit and use them. Show lenders that you are a good credit risk and that you have overcome the issues that caused your short sale or foreclosure.
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