Short Sales (SS) are a topic of much confusion and when it comes to how they affect scores it is no different.
I have written a few articles about this topic in the past but since there have been many rumors lately it seemed a good time to bring it up again.
The rumors I have heard are "Short Sales don't affect your credit" and "Short Sales NOW drop your score 200 points".
The truth is they do affect your credit because they are considered "Settlements".
Like a settlement a SS is an agreement between the creditor and the consumer to take a sum lower than the debt owed, usually immediate, for full payment of the agreed upon 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 a SS sale are slim.
It is about as likely as when it happens with a credit card settlement and that is about 5% of the time.
The other rumor about SS's dropping the score 200 points could be true depending on what score we are discussing.
For this article we are addressing the Fico Score since it is the one used by banks when approving a Mortgage.
What we know is the higher your credit score the lower it drops with any delinquency.
When having a SS, if there are no prior late payments, the score can drop up to about 110 points.
Most of the 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 having financial problems.
Those with recent negatives may see up to a 150-200 score drop but this is due to many derogatory accounts.
If the score was already low it will probably drop another 50-60 points from a SS.
If the score was a 780 it could drop as low as a 680 even with no other negative accounts.
The scoring system already had definitions of score drops from settlements way before Short Sales came along.
When you think about it a SS is the same as a settlement on any debt.
The creditor takes less than full balance and writes off the difference as a loss.
The consumer is released of responsibility for the unpaid difference.
This is why it affects the score in the same way.
The scoring systems view it as a "Settlement".
Many consumers don't realize how much one new late payment destroys their scores.
If they have a SS, pull their credit a few months later, and see a 200 point score drop they may assume it is all due to the Short Sale.
What they probably don't realize is all the late payments on one or multiple accounts prior to the settlement had already decreased their score dramatically.