How does short sale affect your credit?
A short sale of real estate happens when the owner of the home or property owes more on the property than what it sells for. This can happen when a home owner chooses to sell when property values have dropped drastically or when an owner has taken out equity loans on top of the mortgage loan and the loans equal more than the value of the home. A short sale can also occur when a homeowner is forced into foreclosure and the bank sells the house for less than the amount still owed. In any case, when all is said and done, the owner comes out owing money instead of earning a profit after the sale of the property.
The credit implications for a short sale are very different for those voluntarily selling their property and those forced into foreclosure. If the property owner voluntarily selling the property can pay off the amount owed out of pocket by using assets already owned there should be no credit implications. If the property owner needs to take a new loan from a bank in order to make up the difference from the short sale, then the credit implications would be the same as the credit implications of taking out any loan. In fact, sometimes taking out a loan can improve a credit rating. Whether the new loan raises a credit score or lowers a credit score, most likely the new credit score will not be drastically different than the property owner's credit score before the short sale.
However, if the short sale is due to foreclosure, the property owner's credit could be negatively and severely affected. Here is why. Say the homeowner owes $100,000 on the foreclosed property, but the lender only gets $70,000 from the sale. The lender can then sue the homeowner for the $30,000 difference. But, the homeowner won't have the $30,000. If he did, he most likely wouldn't have gone into foreclosure in the first place. If the lender chooses to sue, and the homeowner cannot pay, a deficiency judgment would appear on the homeowner's credit report, negatively affecting the homeowner's credit.
Often, the bank chooses not to sue, but to take the loss as a tax write-off. In this case, there would be no deficiency judgment on the homeowner's credit report; however, there is another implication. The $30,000 that the homeowner did not have to pay would be considered by the IRS to be income. The lender will send a 1099 to the homeowner at the end of the year, and the homeowner will be required to pay taxes on that $30,000. Even when the bank chooses not to sue, the foreclosure can end up showing up in credit checks because it is a public record.
It depends in large part who is negotiating your sale. I would never agree to a short sale if the person negotiating the sale could not protect me from future law suits (ie: deficiency judgement). The truth is there are options if you are informed. So many of the real estate agents claiming to do short sales learned from some silly weekend training and have no clue how to properly negotiate the deal. My clients walk away with only the mortgage lates (from missing payments) damaging their credit, as for the account that was sold short (the mortgage) it will show: paid as agreed.
It's necessary to update the above postings as new laws have changed the rules...
The Mortgage Forgiveness Debt Relief Act of 2007, H.R. 3648 says that the portion the lender forgives is NO longer counted as personal income and CANNOT be taxed by the Federal Government.
This is new since December 20, 2007 and was not in effect while the above answers were being generated.
Short sales are the best thing to do if:
You're already behind and the bank will foreclose if you do nothing else, such as a loan mod/refi etc.
The proceeds from the sale of your house are estinmated to be less than the payoff and no money will be available to satisfy it.