3 devastating consequences of a short sale

Short sales have become one of the preferred ways many homeowners relieve themselves of an underwater mortgage. This is often seen as a better alternative to a foreclosure since the mortgage balance is forgiven and nothing is reported to public records which can then end up on your credit report.

However, many fail to understand the devastating effects of a short sale. For this reason, it is important that you plan strategically while understanding the consequences when initiating a short sale.

Prior to the short sale

1. If you're considering a short sale, plan the sale in such a way that you're able to secure another place to live before your credit score takes a dip.
2. Discuss with your realtor how you will address concerns around your credit once the short sale is completed. Whether you plan to buy or rent another home, there will be questions and you need to be able to answer. They should be addressed in a manner that does not raise red flags about your ability to pay your monthly obligations moving forward.
3. Pay your mortgage through the end of the sale. This preserves your credit and reduces the amount of delinquent payments on your credit report

Now that we understand how to plan strategically, let's discuss the potential consequences of a short sale. Many believe that a short sale has consequences, however this is not the case.

Short sales are reported equally as foreclosures

A common myth amongst homeowners is that short sales are less damaging than a foreclosure reported on your credit report. This is untrue. The short sale indicates that you were unable to fulfill your financial obligations and this always results in a deep dive of your credit score, just as a foreclosure would.

The common alternatives to foreclosure, such as short sales, and deeds-in-lieu of foreclosure are all "not paid as agreed" accounts, and considered the same by your FICO® score. This is not to say that these may not be better options for you from a financial perspective, just that they will be considered no better or worse for your FICO score. - MyFico

This is why it is important for you to keep making payments through the completion of the short sale. Adding delinquent payments to the short sale increases the damage.

Difficulty obtaining a new loan

After the short sale, you may encounter difficulty securing a loan that doesn't involve what may approach usurious interest rates. And, rightfully so. Lenders want to make sure that if they take a risk lending you money, they are paid handsomely for doing so. Be sure to connect with the lender or whoever may be reviewing your credit report to explain your situation, while assuring them based on current assets that you will be able to fulfill your monthly obligations.

Mortgage waiting game after the short sale

The Federal Housing Administration mandates:

....a two-year wait after a short sale, deed in lieu, or discharge or dismissal of bankruptcy, and three years after foreclosure. Without extenuating circumstances, waits can extend to four years after bankruptcy and seven years after foreclosure. -NY Times

If you were thinking about purchasing a new home right after the sale, then you're out of luck for 2 years. At a minimum. Plan ahead and secure your new home prior to the short sale. This will require consultation with your realtor and possibly a real estate attorney depending on your situation.

In the end, when handled properly, short sales can be better than a foreclosure because nothing is reported to the public records and the balance is forgiven. However, we discussed above, there are other deleterious effects that must be planned for in advance.