For most homeowners, receiving a Notice of Default from the bank is a nightmare. Many people in default on their mortgages have been diligent with payments and have excellent credit ratings, and then something unforeseen occurs, like a hardship, loss of assets, loss of a job and flat-out inability to catch up with the payments.
If you're dealing with such circumstances, you see that your payment defaults mean that soon, the property will go into foreclosure, and there's nothing you can do about it. Or is there?
A pre-foreclosure strategy called a short sale means foreclosure can be avoided and the auction gavel need not lower on your home. When a bank accepts a short sale proposal from a buyer, they're selling the home for less than the actual amount owed on the home, but the advantage to the bank is that they can avoid costs associated with foreclosure and subsequent ownership. The buyer gets a good deal, and you, the homeowner, are spared the shame and credit damage associated with foreclosure.
The question is: Will a short sale help or hurt your credit?
When you fall behind on mortgage payments, every step along the way impacts your credit. How bad is the credit rating impact from a short sale?
The sad fact is that a short sale does negatively affect your credit. Such an agreement goes into your credit report as "paid settled," which is a term understood by people in the business to mean that only a portion of what was owed was actually paid back. "Paid settled" on your credit report will have an adverse impact on the score.
In general, the resulting credit impact of a short sale is less damaging than it would be from a foreclosure. But arguing short sale versus foreclosure in terms of credit impact might be like ignoring the elephant in the room. The biggest hit of all to your credit score may be what led up to the entire matter. The delinquent payments, the Notice of Default and payments missed subsequent to the notice are what likely carry the most weight in your personal credit report wrecking ball.
If you can possibly keep current while negotiating a short sale, do it! Your credit report will take the least hit possible.