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.
Securing a New Place to Live
If you're headed for a short sale but doubt you can catch up on payments in the meantime, you may be advised to secure a new place to live now, rather than waiting until the short sale shows up on your credit report. But bad credit is going to make it hard to get approved for a new residence. Trying to rent an apartment, for example, may not be possible with bad credit. If your home is foreclosed, that leaves you nowhere.
As soon as possible -- the minute you see that you may be about to fall behind on your mortgage and believe you won't be able to catch up -- begin the lease application process. If circumstances with your home change for the better, you may be able to sublease the rental or back out (probably at a price), but at least you won't be homeless.
Taxes are another important consideration when you're looking at a short sale. Tax laws regarding short sales tend to vary, and some years you may be liable for paying taxes on the difference between the purchase price and what you actually owed on your house. The bank would send you a 1099 form showing the amount they forgave. The amount on the 1099 then shows up just like any other income for you, and you'll pay income taxes on it just as you do regular income from your job. Be sure to know the IRS implications of a short sale. Sometimes you or your accountant can negotiate with the bank the manner in which the "paid settled" will be reported to the IRS.
For more information, check out the links on the next page.
- All About Real Estate Short Sales. "Strategies for Locating Short Sales." (Feb. 27, 2011) http://www.realestateshortsale.net/buying-short-sale/short-sale-strategies.html
- Cunningham, Barry. "Buying A Short Sale For Maximum Profit With The Help Of A Realtor." Real Estate Radio USA. March 14, 2010. (Feb. 27, 2011) http://www.realestateradiousa.com/2010/03/14/buying-a-short-sale/
- Evans, Mariwyn. "Sold up short: How to Succeed at Short Sales." The National Association of Realtors. (March 8, 2011) http://www.realtor.org/archives/feat1200706
- Foreclosure.com. "Real Estate Short Sales." (March 2, 2011) http://www.foreclosure.com/shortsales.html
- Foust, Dean. "The new exit strategy: A short sale." Bloomberg BusinessWeek. March 5, 2007. (Feb. 27, 2011) http://www.businessweek.com/the_thread/hotproperty/archives/2007/03/the_new_exit_strategy_a_short_sale.html
- Information-Valley.com. "Working Default Listings." 2005. (Feb. 27, 2011) http://www.information-valley.com/defaultListings.html
- Levy, Dan and Prashant Gopal. "Foreclosure Filings in U.S. May Jump 20% From Record 2010 as Crisis Peaks." Bloomberg. Jan. 13, 2011. (Feb. 26, 2011) http://www.bloomberg.com/news/2011-01-13/u-s-foreclosure-filings-may-jump-20-this-year-as-crisis-peaks.html
- Michigan's Compassionate Foreclosure Solutions. "Realtors Get Help for Homeowner Short Sales." (Feb. 26, 2011) http://www.miforeclosurerelief.com/realtors-helping-homeowners-get-help-with-short-sales/
- RealtyU. "Short Sale: Certified Short-Sale Professional (CSP)." (Feb. 27, 2011) http://www.realtyu.com/short_sale_class.htm