Many people have called or written to me regarding the impact of a short sale on a credit report and how long it will stay there.

When negotiating with a Short Sale Lender, one of the things up for negotiation is how the mortgage account will be reported. The instrument (legal document) for the mortgage will also make a difference.

On an earlier post, I discussed how a short sale, foreclosure, or deed in lieu of foreclosure all has the same impact on a credit score. Even though I wrote my authority on this as being MyFICO.com, the owners of the Fair Isaac Company, people still want to argue with me about it. There is still much more that is unknown about credit scoring than is known, so I take the info on MyFICO.com seriously.

A lot of times what they are arguing about is another aspect of why one would do a short sale over going with a foreclosure. There can be a number of reasons, an important one being the perception of a foreclosure to the homeowner or the expertise of the advice that they take. My expertise is in California where I hold a real estate license.

If a Short Sale is selected or has already occurred, the actual reporting of the mortgage account will have different time lengths for being reported on a person’s credit.

If the reporting is “Settled For Less Than Agreed”, then the credit reporting will be included on a person’s credit report for 7 years. The impact on the credit scores will be great, with the most impact over the first two years.

If there were late payments on the mortgage, those late payments will be reported on the credit report for seven years and will also have an additional hit to the credit scores for each late payment.

If a “Notice of Default” has been filed, the credit report may include a notation that “Foreclosure Started” even if the foreclosure is not completed. In California, for instance, the late mortgage payments after three months of no payments can generate a “Notice of Default” which is a document that is recorded and appears in the public record. Those types of documents stay on a person’s credit report for ten years.

It is possible to sell the property at a Short Sale and also already have late mortgage payments and a Notice of Default filed against the property. If that is the case, then the “Foreclosure Started” comment can appear on the credit report and remain for ten years. If you sold at the Short Sale, you could then have the double whammy of the Notice of Default and the account with reporting that states “Paid for Less Than Agreed”. That would shred a person’s credit scores for a minimum of two years unless the person took steps to rebuild the credit profile.

It is also possible to have two or three mortgage late payments and negotiate in the Short Sale for the account to be reported without the late payment history and the mortgage to be reported with “Paid As Agreed”. I stress the word possible because I have counseled with many home owners who tried to negotiate for this wording into the reporting of the mortgage. Typically the lender will want a very larger sum of money for this. The homeowner would need to pay into what is short on the sale and participate with the lender in the loss that is taken on the property.

One of my clients agreed to pay $125,000 on his loan and the attorney was still not able to get the reporting to come in as “Paid As Agreed”. He is still paying on that loan after the escrow closed. I am not sure how typical that is, but I believe that the credit scoring models will be changed to mitigate that.

I believe that all of the Short Sales, Foreclosures, and Deed In Lieu of Foreclosure will likely all be re-worked into the credit scoring systems used by the big three credit repositories. I have heard of different ways of Short Sales being reported, but I have not yet seen an actual report that deviates from what I have stated above.

The bottom line when asked, “How long will a Short Sale appear on my credit report?” is the answer “It all depends on how it will be or is being reported by the lender. It is possible to negotiate that reporting prior to the Short Sale and very unlikely after the sale.”

In my next posting, I will discuss the lender’s point of view as it affects the credit score point of view.