Opting for a Short Sale? Beware the Cost to Your Credit

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The mortgage crisis of 2008 left John Markson much like it did tens of thousands of homeowners across the country -- stuck, stressed and forced to make desperate and costly financial moves.
For Markson, it hit especially hard. He is a deck-builder by trade, and when the real estate market dried up, so did the work and his salary. Meanwhile, the Philadelphia home he'd lived in for barely two years declined in value,

The mortgage crisis of 2008 left John Markson much like it did tens of thousands of homeowners across the country -- stuck, stressed and forced to make desperate and costly financial moves.

For Markson, it hit especially hard. He is a deck-builder by trade, and when the real estate market dried up, so did the work and his salary. Meanwhile, the Philadelphia home he'd lived in for barely two years declined in value, and his monthly mortgage soared from $1,700 to $2,500 a month thanks to an adjustable rate. Worse, he couldn't find a bank to refinance the loan. It was time to make a move.

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When faced with this situation, homeowners tend to do one of three things -- walk away from the mortgage, face foreclosure or opt for a short sale. Markson chose the latter.

"It was devastating to me. I'd invested my time and money in this place," said Markson, whose three-bedroom house has been on the market for a year. "This was my home. It was my first house and I was attached to it."

Just a smidge better than a foreclosure, a short sale is an agreement from the bank to accept less than what is owed on a loan to release a homeowner from a mortgage obligation. (Markson bought the house for $250,000, but last year listed it for $160,000 per the agreement.) The downside of a short sale: it shows up on your credit report, and not in a nice way.

Markson's once "good" credit score of 720 has dropped nearly 100 points.

"Credit agencies report out that the loan was not paid in full, which hits you almost as hard as a foreclosure," says Lita Epstein, author of "250 Questions You Should Ask to Avoid Foreclosure." "I always recommend they have an attorney who understands tax law and who can negotiate on their behalf."

Explains Epstein, an attorney could make a deal and advocate that the bank help protect your credit as part of the payment agreement. For example, have the sale reported to the agencies as "paid as agreed" which looks more responsible than say, a "charge-off." Like a foreclosure, short sales stay on your report for seven years.

"Most people don't know this, but if you can prove a hardship, banks may be lenient," Epstein says.

Rick and Sara Johnson have credit scores in the low 500s, ever since losing their six-bedroom, 5,000-square foot Colonial in last year. In the thick of it, they owed $650,000 plus six months of late payments on two mortgages.

"It's hard, and it's embarrassing," Sara says. "We're so behind in our plans for the future."

After eight months on the market, the house sold and both mortgage companies accepted a total of $417,000. Today, they're living in a three-bedroom rental in Maryland with their two kids and dog, trying to get their credit back in shape.

Markson is doing the same as he looks for a renter to occupy his home.

All isn't loss for short-sale survivors. It may take some time and commitment, but Epstein says most can get back their good name and credit in 3 to 4 years. Consider her tips:

-- Pay your bills on time or early. Paying a bill a week before its due and before the new balance is reported kicks up your credit score. Show the lending industry that you are responsible.

-- Be careful not to take on too much credit. It makes you look careless and irresponsible with your finances.

--Obtain one secured credit card and use it for 6 months or more. The card is linked to a savings or checking account.

-- Keep the balances very low. People with good credit generally use 10 percent of their credit.

--Don't try to hide the fact that you had a short sale. "If you find a good broker, they'll tell you how to work around it." Be upfront because you'll never be able to hide it.

"People do get loans again," Epstein says. "But they're going to jump through a lot more hoops and pay a higher mortgage rates."

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