Short selling (SS) is a subject of much confusion and when it comes to how it affects scores, it’s no different. I have written a few articles on this subject in the past, but since there have been a lot of rumors lately, it seemed like a good time to bring it up again. Rumors I’ve heard are “Short sales don’t affect your credit” and “Short sales NOW lower your score by 200 points.” The truth is that they affect your credit because they are considered “Settlements”. Like an agreement, an SS is an agreement between the creditor and the consumer to take a sum less than the debt, generally immediate, for the full payment of the agreed amount. There may be exceptions to this rule in rare cases where the bank agrees NOT to update the credit report as a negative account. The chances of this happening with an SS sale are slim. It’s about as likely as when it happens with a credit card payoff and that’s about 5% of the time.
The other rumor about SS dropping the score by 200 points could be true depending on the score we’re discussing. For this article we are referring to the Fico Score since it is the one used by banks when approving a Mortgage. What we do know is that the higher your credit score, the lower your level of delinquency. By having an SS, if there are no prior late payments, the score can go as low as around 110 points. Most consumers approaching a short sale have already had recent late payments on their mortgage or even other credit accounts. Let’s face it, the typical SS applicant is currently struggling financially. Those with recent negative results may see a score drop of as much as 150-200, but this is due to many derogatory accounts. If the score was already low, it will probably drop another 50-60 points from an SS. If the score were 780, it could drop as low as 680 even with no other negative accounts.
The scoring system already had definitions of deal scoring drops long before short sales came along. When you think about it, an SS is the same as a settlement on any debt. The creditor takes less than the full balance and writes off the difference as a loss. The consumer is released from liability for the unpaid difference. That is why it affects the score in the same way. Scoring systems see it as a “Deal”.
Many consumers don’t realize how much a new late payment destroys their scores. If they have an SS, pull their credit a few months later, and see a 200 point drop in score, they may assume it’s all due to the short sale. What they probably don’t realize is that all the late payments on one or more accounts before the settlement had already drastically lowered their score.