A short sale is going to do some damage to your credit. However, it doesn't have to be devastating and there are ways to minimize that damage. If you can complete the short sale before the bank initiates foreclosure proceedings you are much better off. However, even if they initiate proceedings it is beneficial to complete the short sale so there will not be a public record of a foreclosure on your credit report. It will be reported as being settled for less than the amount owed and at this point in time (February 2010) if the bank initiated foreclosure proceedings that trade line will indicate that it was in pre-foreclosure status.
Prevent your Loan from Getting so far Behind that Foreclosure is Initiated
In Arizona it is fairly easy to know when you are getting close to the point where the bank is going to initiate foreclosure proceedings. Borrowers here receive a Breach Letter which states that the borrower has a certain amount of time to cure the breach before the bank can/may move forward with a foreclosure. Sometimes the bank does not move forward even if the borrower does not cure the breach but it is safer to assume that they will. Often a breach letter will give you an option to make one or two payments to cure the breach. Sometimes they ask that you pay all of the past due amount. Either way, if you have the money to make at least one payment you can usually talk to your bank and buy more time. They really do want you to cure the default.
Timing Your Default
Sometimes I am contacted by sellers who are very far behind in their mortgage payments and have already used up their savings trying to make payments on their home. On the other hand, I am more often contacted by sellers who are more proactive and realize that due to circumstances beyond their control their default is pending, but they are not yet late on their payments. As short sales and foreclosures have become more commonplace, there is less embarrassment about being in this predicament and I think that has made it easier for people to take more control of their financial situation by acting earlier.
If you have not yet defaulted, yet know that there is a limited time before you will get behind on your payments, now is the time to act. Depending on what bank you have, the short sale approval process can take varying amounts of time. If you get your property on the market right away you may be able to get an offer before you default. That is ideal because it will take at least 30 days to process your short sale even with the faster banks.
Why even default at all?
Unfortunately, I have not found any bank that will approve a short sale without someone being behind on their payments. Their mindset is that if you can make your payments then there is no reason for them to approve a short sale. In the real world, however, I have come across many clients who, in trying to be responsible, work to get a short sale done BEFORE they know that they will be late. This occurs often when a cross-country job transfer is imminent or when savings are dwindling with no hope of recovery. In my experience, a homeowner must be at least 30 days behind on their payment before the bank/investor will approve a short sale.
Keep your Other Obligations Current
As much as possible, keep your other credit obligations current while doing a short sale. This will enable your future creditors to see that while you may have run into trouble with your home, you still remained responsible and paid as many items on time as was possible. This will also cause your credit score to rebound in the fastest amount of time after the short sale.
