A foreclosure hits a homeowner twice: first by taking away the home, then wrecking his credit. To avoid a black mark on credit scores, an increasing number of homeowners are working with lenders to sell their homes for less than what they owe. This process is known as a short sale, and while it can offer a good alternative to foreclosure, it's not without a few pitfalls. A short sale is frequently an option when home values have declined, leaving a homeowner owing more than the home is worth. The lender, which must approve such a sale, receives the proceeds from the short sale and the debt is considered settled. Even though the homeowner will lose his home, a short sale has its benefits: Done well, the bank gets most of its money back and avoids a costly foreclosure process, and the homeowner avoids an unsightly blemish on his credit report. But not all short sales go smoothly. Indeed, the condition of your credit after a short sale depends largely on how your lender chooses to report the status of the account. If it reports the account as "satisfied," your credit should be fine. But if the lender reports the account as "settled for less than the full amount," your credit score will take a hit. How big of a hit? That depends on the specifics of your credit history. Your credit score may survive better if you have a number of other accounts in good standing and a long history. A short sale may not drop your credit rating by the 200 or 300 points expected from a foreclosure, but it may make you less attractive to future lenders or others that may look at your credit score.
To reduce the impact on your credit score, negotiate the reporting terms with your lender. A lender can report your account as "satisfied," agree to leave the account unreported or delete it altogether, all of which will have relatively neutral effects on your credit score. Make sure to get your lender's terms in writing, and consider hiring a real estate lawyer to help with negotiations. (To find a local real estate lawyer, ask around with friends and family, search online at www.lawyers.com or check the member roster of the American College of Real Estate Lawyers.)