If you’re “upside-down” in your mortgage (owing more than the property is worth), you have a few options. One of them is a short sale. The process is complicated and confusing, often leaving a worrisome question in its wake: How long does a short sale stay on your credit? Along with extensive research, we consulted with Richie Helali, mortgage sales lead at HomeLight Home Loans, and Christina Griffin, a top agent who works with 68% more single-family homes than the average Tampa, Florida, agent, to help decipher the long and short of short sales.
What is a short sale?
A short sale is an alternative to foreclosure in which the homeowner gets permission from the lender to sell the home for less than is owed. Homeowners typically request a short sale due to some form of financial hardship, and must be able to prove their inability to pay.
Short sales aren’t common in the current market, according to Helali, but can occur when competitive buyers have overbid due to low inventory and high demand.
To prove financial hardship, you may have to provide pay stubs, W-2s, collection letters, utility bills, proof of other debts (such as student or car loans), proof of income (or lack thereof) and a hardship letter. Helali advises consulting your loan servicer, as requirements vary amongst lenders.
Once you gain the lender’s approval, you can list your home for sale. Typically, it’s best to list it at market value to recoup as much money as possible. It will be listed on the multiple listing service (MLS) as a short sale, which could deter some buyers due to the added steps and time it takes to transact a short sale, so it’s important to hire an experienced real estate agent — and possibly an attorney.
When you receive an offer, your agent will need to submit it to the lender for approval, which can be a lengthy process. Your agent will also ensure that all additional legal guidelines required in a short sale are followed.
A short sale can take as little as a few months, but that’s rare. A conservative industry estimate might be six months, start-to-finish. Many take a year, sometimes more. Patience is a necessary virtue for any seller going through the short sale process.
What you’ll still owe
If you sell your house for less than you still owe on it, you may still remain responsible for making up the deficiency — the difference between the sales price and the outstanding mortgage balance.
Depending on where you live and the details of your short sale, the lender may be able to get a deficiency judgment and attempt to collect the debt, possibly by arranging a payment plan, by placing liens on any personal property you own, or by garnishing your wages. Some states limit the time a lender can attempt to collect on the deficiency judgment, and a few states restrict or disallow deficiency judgments completely.
Helali says the point of a short sale is that the homeowner can’t pay for the property, and the goal is for the seller to no longer be obligated to make up the difference between the home’s sale price and the balance on the mortgage. But a court-approved deficiency judgment following a short sale allows a lender to attempt to collect the additional funds.
If you’re struggling to pay the deficiency, your lender may consider accepting a settlement offer in which you pay back a portion of the amount you owe. Griffin says that as part of the negotiation, an agent should ask the lender to waive the deficiency judgment. “A lot do,” she says, especially if the hardship resulted from COVID-19.
When you can convince a lender to forgive the amount and accept the lesser sales price as payment in full for your mortgage, they’ll issue you a 1099-C Cancelation of Debt form. Forgiven debt is reported to the IRS by your lender (via the 1099-C) and is considered taxable income, so you’re still on the financial hook for paying any resulting taxes.
The differences between a short sale and a foreclosure
A short sale and a foreclosure are slightly different in how they affect your credit and future mortgage prospects, but both will remain on your credit report for at least seven years, Helali says. One key difference between them: A short sale is homeowner-generated, while a foreclosure is initiated by the bank.
Lenders initiate a foreclosure when the homebuyer has fallen behind on loan payments — usually three to six months. The lender must take legal action to seize the property of a delinquent borrower and sell it at auction. Foreclosures are common when the homeowner has abandoned the home. If the occupants are still in the home, they can often be evicted by the lender. Once the lender has possession of the home, an appraisal will be scheduled so the property can be liquidated quickly.
With a foreclosure, the bank assumes ownership of your home, relieving you of many selling tasks. But a homeowner must use a real estate agent to do a short sale, Griffin says. “You can’t do it on your own.” One reason is that only an agent can list the property on the MLS, but you’ll also want an agent to help navigate the river of paperwork and negotiate with the lender on your behalf.
Another difference becomes apparent afterwards. According to Fannie Mae’s guidelines, you can apply for a new mortgage four years after a short sale, with a 10% down payment. If there were extenuating circumstances that led to your short sale, that can drop down to two years, but you must provide documentation regarding the special circumstances. Freddie Mac’s requirements are similar. FHA’s are even less stringent: you can apply for a FHA loan one year after a short sale.
According to Griffin, it takes five to seven years after a foreclosure before you can apply for a new mortgage.
- Can take several months to a year to complete
- Can allow a borrower to purchase another property with a conventional mortgage in two to four years, on average
- Deficiency judgments can be negotiated
- Not required to mention on future home loan applications
- Stays on your credit report seven years or more
- May be immediate but typically take a year or more
- Can allow a borrower to buy another property with a conventional mortgage in five to seven years, on average
- Deficiency judgments cannot be negotiated
- Required to mention on future home loan applications
- Stays on your credit report seven years or more
How long does a short sale stay on your credit report?
It’s pretty cut and dried with foreclosures: they stay on your credit report for seven years … or more. However, it gets a little more complicated with a short sale. As with foreclosures, short sales remain on your credit report for seven years, although it’s not as cut and dried.
For example, if you were late on your mortgage payments, a short sale will remain on your credit report for seven years from the delinquency date. But if you were never late, the seven-year clock starts on the date it was marked settled or paid.
Nevertheless, thinking a short sale will have less negative impact on your credit score than a foreclosure is a common credit score myth. Bottom line: there is no way to avoid hurting your credit score with a short sale.
A seller’s credit score can take a hit of 85 to 160 points after a short sale.
In general, the effect of a short sale on your credit score is comparable to the impact a foreclosure has on your score. However, the damage to your credit score can vary, depending on how the lender lists the sale. Many times, short sales are recorded as “settlements” instead of “debt paid.” This is a clue that the lender accepted less than it was owed. That has a negative impact on your credit score.
If, on the other hand, the lender reports a short sale as “paid,” there will be less negative impact on your credit rating. It’s rare and usually only comes as a result of extensive negotiation. It helps if you never missed a payment, if your credit history is otherwise good, and if you provide a hardship letter outlining the extenuating circumstances. The FHA describes extenuating circumstances as “circumstances that were beyond the control of the borrower, such as a serious illness or death of a wage earner.”
Any late payments on your mortgage that preceded the short sale will also have a negative effect on your credit, separate from the damage caused by the short sale alone. Keep in mind, a deficiency judgment will appear on your credit report in addition to the short sale, potentially adding to the credit damage.
How the short sale could appear on report
Reading a credit report gets confusing because a short sale probably won’t even be listed as a short sale. It’s more likely to be listed as:
- a derogatory mark
- a charge-off
- a settlement
- “settled for less than the full amount due”
- “not paid as agreed”
The term “short sale” won’t appear on your credit report.
Can you get a short sale removed from your report?
It’s not impossible to have a short sale expunged from your credit report, although Helali says it’s unlikely. Technically, there’s no law forcing creditors to report delinquencies on your credit history (other than missing child support payments).
If a creditor does report it, the creditor can remove it at your behest. The best approach is to write a letter to the creditor, asking them to remove the comment.
Another tactic is to report an error on your credit report if a short sale was mistakenly listed as a foreclosure. Because there is no code designating a short sale, some credit bureaus substitute the foreclosure code. If your credit report reveals such an error, you can contact a Fair Credit Reporting Act attorney to help you get it removed.
Be aware that even if you do manage to get the short sale removed from your credit report, Helali says it may still show up when new lenders conduct a background check.
How can I fix my credit after a short sale?
If you can’t get the short sale removed from your credit report, you’ll have to start rebuilding good credit the hard way. Be aware that it can take three to seven years, depending on how good your credit score was before.
Remember that your credit may rebound faster with a short sale than a foreclosure, Griffin notes.
Start by getting a copy of your free credit report from all three credit bureaus: Experian, TransUnion, and Equifax. Check for errors. More than 80% of credit reports have mistakes that hurt your score.
Your checklist should include the following actions:
- Look for debts owed by people with similar names and medical collections.
- Check the report for suggestions about how to get a higher score.
- Don’t close any credit accounts. The length of your credit history is helpful.
Other tips to help rebuild your credit rating include:
- Pay down debt as much as possible, especially on revolving accounts like credit cards. The debt-to-credit ratio is important to your credit rating. About 30% of your credit score reflects your credit card balance. Regardless of your income, lowering your credit utilization ratio will improve your score.
- Make all payments on time.
- Consider opening new accounts to establish good credit. (However, Helali says, it can be difficult to open new accounts in the immediate aftermath of a foreclosure.)
- Consider opening a secured line of credit to help improve your credit score. Secured cards and credit-builder loans are good options.
- Ask the lender for a 1099-C instead of a deficiency judgment. This is a cancellation of debt, and will make it easier to begin repairing your credit rating if you don’t have to cover the deficiency.
- Consult an attorney specializing in bankruptcy.
The best way to repair your credit, Helali says, is to “make your payments on time and keep your balances low.”
Griffin concurs, adding that establishing good payment history is vital in fixing your credit rating. But she has noticed over the years that if a person has been delinquent on their mortgage, they’re likely to be delinquent on other bills as well, so reestablishing good payment history is an uphill climb.
Alternative tactics may work better than a short sale. A CoreLogic report indicates that U.S. homeowners gained 10.8% in equity from 2019 to 2020. Your home may be worth more than you think, allowing your equity to help cover your debt.
“Talk to your lender,” Helali urges. “Banks want to help. They don’t want to own your home.” He lists some of the fees banks become responsible for if they foreclose on a property, such as attorney’s fees, county fees, and other expenses. He says banks would rather help homeowners stay in their homes than take properties and go through the hassle of selling them.
Before choosing a strategy, explore available resources and weigh every option to determine what’s in your best interest.
- Start by contacting your lender to find out what options they offer. Fannie Mae and Freddie Mac offer programs to help borrowers avoid a short sale or foreclosure. “Start early,” Griffin advises, “before you’re delinquent.”
- Have your real estate agent ask the lender about a “cash for keys” relocation package. Because the servicing company pays the agent’s commission, there are no expenses. Even better, Griffin points out, the homeowner gets a few thousand dollars for moving expenses.
- Consult the U.S. Department of Housing and Urban Development’s resources to help homeowners avoid foreclosure.
- Investigate the possibility of refinancing to get a better rate.
- Put your mortgage into forbearance. Forbearance plans are included in the assistance offered by the government to homeowners struggling due to the coronavirus pandemic. Forbearance allows you to temporarily pause or reduce mortgage payments. Under the CARES Act, lenders cannot require borrowers to pay the money back in a lump sum. “Forbearance is the most common option,” Helali comments.
- Look into additional mortgage relief options provided by the government through the CARES Act.
- Seek a loan modification to lower the payment amount, lengthen the term of the mortgage, or lower the interest rate. To qualify, you’ll need to apply with your lender and show proof of hardship.
- Ask your lender for a payment plan.
- Sell your home to a third party. This can still be done after you receive a demand letter from the lender, even if an auction or foreclosure has been scheduled. HomeLight’s Simple Sale can take off some of the pressure with its benefits of no showings, no agent fees, and all-cash offers. If you sell with an agent, make sure the sale price will cover selling fees, which can cost 9%-10% of the sale price, as well as any attorney’s fees and late fees you may owe. Otherwise, you may have to pay those charges out of pocket.
Find an experienced real estate agent familiar with short sales, as well as dealing with lenders and attorneys, to help you manage your situation.
Don’t be afraid or embarrassed to go through the process.
- Christina Griffin Real Estate AgentCloseChristina Griffin Real Estate Agent at Keller Williams Realty Currently accepting new clients
- Years of Experience 21
- Transactions 3055
- Average Price Point $160k
- Single Family Homes 2436
A short sale is not an easy way out of a mortgage you can no longer manage. You must go through a rigorous process and produce prodigious amounts of paperwork to qualify. And if you do qualify, it will put a blot on your credit record for several years.
“Don’t be afraid or embarrassed to go through the process,” Griffin says. Fear sometimes delays homeowners from getting started on the road to a short sale. And while the road may be long and can be bumpy, it might be the best path to the solution you need and a chance to start over.
Header Image Source: (Xavier Foucrier / Unsplash)