If your mortgage lender forecloses, it can knock more than 100 points off your credit score. Contrary to popular belief, a short sale is often just as harsh. In a short sale you find a buyer for the house, in return for which the lender agrees to wipe out any remaining debt. You still defaulted on your mortgage, so it's still going to have a bad effect on your report.
The impact of a short sale isn't uniform because credit histories aren't all alike. If your credit history is already troubled, a mortgage default will cause your credit score to take a big hit, but your credit score will typically take an even bigger hit if you had excellent credit. The circumstances of the sale matter too: the more debt left over that you don't pay, the worse the credit hit. If you can convince the lender not to report the debt deficiency, the damage is less.
Nothing stays on your credit report forever, but mortgage defaults sit there for around seven years. You can start rebuilding your credit almost immediately, but it can take up to seven years before your score is as good as it used to be. The better your credit, the longer it takes -- if yours is around 680, you can work your way back up to that number within three years. At 780, you can expect a seven-year time-frame.
If you know you can't afford to keep up the mortgage, short sales do have some advantages. Once you start falling behind on your mortgage payments, the credit damage will be pretty bad even without the foreclosure. A short sale closes out the account and stops the constant late payments. You can start rebuilding your credit without waiting months more for the inevitable foreclosure to put an end to your problems.
The government-backed mortgage corporation Fannie Mae requires lenders to wait seven years before issuing a mortgage for someone with a foreclosure on a credit report. When you have a short sale instead, you only have to wait two years before trying home ownership again. The National Association of Realtors notes that just avoiding the word "foreclosure" on your credit score may make you look more acceptable to lenders, despite your damaged credit score.
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