Short Sale: What It Does To Your FICO Scores

Short sales happen when a lender agrees to accept less than the amount owed by the borrower – there is not enough equity to sell the house and pay all the costs of the sale. Some lenders will not consider a short sale if the payments are current, and in addition may try to tap into other accounts where the borrower has assets. Generally speaking, the borrower must be unable to pay the existing mortgage, and the property must be worth less than the borrowed amount.

Short sales come with advantages and disadvantages for both borrower and lender. For the homeowner, short sales will appear as a "pre-foreclosure in redemption" status, which will reduce their FICO by 75-100 points. (Foreclosures will hit someone’s FICO by about 250 points, and can appear up to 10 years later.) For lenders, foreclosures are much more time consuming and costly and in some states the process can take up to 280 days as interest payments go uncollected, taxes pile up, and attorneys and agents are compensated. The structure may be neglected or damaged during that time. On the other hand, selling a property short of what's owed on the mortgage can get an unproductive asset off an investor's balance sheet quickly. Tax-wise, and this is about to change, the IRS treated the difference between what the homeowner borrowed and what the lender accepted to settle the mortgage as income to the homeowner and is taxable. Lastly, not all lenders will accept short sales as a complete solution to the debt owed and a few banks want promissory notes from borrowers that require them to pay the full amount of the mortgage even after the short sale has been closed. In California purchase money loans are not subject to deficiency judgments, but hard money, home equity, and refinances are.