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Posted April 13th, 2012 under Underwater Mortgage Pitfalls

The Effect of a Foreclosure v. Short Sale on Credit Scores: What Underwater Homeowners Need to Know

Tags: short sale on credit, foreclosure credit, short sale vs. foreclosure

The Effect of a Foreclosure v. Short Sale on Credit Scores: What Underwater Homeowners Need to Know

If you're considering a short sale vs. foreclosure, you need to think about the impact a short sale or foreclosure will have on your credit score. While you can't avoid the fact that your credit score will fall if your lender forecloses or you sell your home in a short sale, you can take steps to limit the damage and repair your credit as quickly as possible.

First, it's important to understand that the effect of a foreclosure or short sale on credit scores is always negative. But they don't affect your credit score in exactly the same way.  

The impact of foreclosure. Credit scores are dinged by foreclosures. Having a foreclosure judgment on your credit profile will cause your score to fall. In addition, depending on how long the foreclosure process takes, you may have months of delinquent payments on your credit report, which also negatively impacts your score.

The impact of a short sale. If you sell your home in a short sale, your mortgage will appear on your credit profile as "settled for less than owed." That's not quite as bad as having a foreclosure judgment on your credit profile. In addition, a short sale usually moves faster than a foreclosure, so there's typically fewer missed payments noted on your credit report.

The bottom line on short sale vs. foreclosure? Both will hurt your credit score, but the foreclosure will have a bigger impact and it will take you longer to recover.

For homeowners who've sold their homes in a short sale, it typically takes about three years for their credit score to get to a point where home ownership is an option again. However, if you choose foreclosure, it might take up to seven years before your credit is strong enough for you to get back into the real estate market.  

If you do opt for a foreclosure or short sale, it also helps to think in advance about what you're going to do to repair your credit. For example, if most of your financial accounts (including your mortgage) are with one financial institution, consider opening additional accounts at other institutions before you stop making mortgage payments. This will give you a more robust credit profile, making it easier to rebuild a strong credit score after a foreclosure or short sale.

If you work in an industry where your employer reviews your credit score on a yearly basis (such as for a security clearance or because you work in the financial industry), you may want to time your foreclosure or short sale to occur soon after your employer pulls your score. That will give you the maximum amount of time to repair your credit before your score is pulled again. You may also decide to pursue a short sale rather than a foreclosure, since the effect on your credit score will be less negative.

Because credit scores are playing an increasingly important role in our lives (affecting everything from your ability to get a new car to your employment prospects), it's critical to consider how a short sale or foreclosure will affect your credit score. Our Homeowner 101 Assessment and Action Plan can help you do that. It helps you see all your available options and their consequences so that you can choose the path forward that makes the most sense for you and your family given your situation.