How Does a Short Sale Affect Your Credit?

What Is a Short Sale?

A short sale occurs when a property is sold to a third party buyer and the lender receives less than the full contractual mortgage payoff. The lender must approve the sale and agree to release its lien. The approval letter should also establish whether the lender:

• •Accepts the proceeds in full satisfaction of the debt
• •Waives the deficiency
• •Releases the homeowner from further liability
• •Reports a zero remaining balance
• •Agrees to a particular final account status or credit remark

Closing the sale and releasing the lien do not necessarily answer all those questions. That is why the approval letter must be reviewed carefully.

Why Remaining Current Matters

Many homeowners do not begin a short sale until they have already stopped making mortgage payments. Their credit reports may contain:

• •A 30 day late payment
• •A 60 day late payment
• •A 90 day late payment
• •A 120 day late payment
• •Additional serious delinquencies
• •A final short sale or settlement remark

In that situation, the credit damage comes from both the missed payments and the final disposition of the loan.

If the homeowner starts early and remains current through closing, those mortgage delinquencies never occur. The lender may still report the short sale or reduced payoff, but the homeowner avoids an entire series of late payment entries. That can leave the homeowner in a materially better credit position.

Can an Attorney Negotiate Better Reporting?

Yes, although it may not be easy. A short sale has an identified sales price and closing statement. The lender knows precisely how much it received and how that amount compares with the mortgage debt. That may make the lender reluctant to remove language such as "settled for less than the full balance."

Nevertheless, the homeowner is providing the lender with something valuable:

• •A qualified buyer
• •The property's present market value
• •An orderly sale
• •Immediate receipt of the net proceeds
• •Avoidance of foreclosure expenses
• •Avoidance of taking and maintaining the property
• •Avoidance of the delay involved in completing foreclosure

The attorney can use that value to request:

• •A complete deficiency waiver
• •Release from all further personal liability
• •A zero reported balance
• •The most favorable accurate account status available
• •The most favorable accurate final credit remark the lender will approve
• •Written confirmation of the lender's intended reporting
• •Correction of any inaccurate mortgage delinquencies

The lender may refuse to change its standard reporting. Investor requirements may also limit the servicer's authority. But the proposed reporting should still be raised and negotiated before the short sale closes. The goal is not to persuade the lender to report something false. The goal is to obtain the best accurate treatment the lender is willing and authorized to provide.

Why an Attorney Should Review These Terms

A real estate broker can market the property, negotiate the purchase contract, submit the short sale package, and work toward lender approval within the scope of the broker's license. But the approval letter also presents legal questions:

• •Is the homeowner completely released from the debt?
• •Has the lender waived the deficiency?
• •Can the lender pursue or sell any remaining balance?
• •Does California law independently prohibit a deficiency?
• •What does the approval language mean for tax purposes?
• •What has the lender agreed to report?
• •Is the proposed reporting consistent with the legal resolution?

Those are not merely real estate sales questions. They concern the homeowner's legal obligations and the consequences of accepting the lender's settlement. California permits only licensed attorneys to provide legal advice.

When Can the Homeowner Obtain Another Mortgage?

Future mortgage eligibility is different from the effect on the homeowner's credit score. Under current Fannie Mae guidelines, the standard waiting period following a short sale is generally four years. It can be reduced to two years when qualifying extenuating circumstances are established.

Freddie Mac uses a similar framework:

For Freddie Mac's two year treatment, the lender must document that the circumstances were beyond the borrower's control, are no longer continuing, are unlikely to recur, and that the borrower has reestablished an acceptable credit reputation. Additional transaction and loan to value requirements also apply. These are eligibility periods, not promises of approval. But they establish that a short sale does not automatically prevent someone from obtaining conventional financing for seven years.