What Is a Short Sale With a Late Payment?

Short sales are sometimes used to avoid foreclosures when the mortgage lender agrees to the terms. Lenders are not obligated to approve short sales, but they sometimes agree if you are already late with your payments and foreclosure is the only other option. The short sale has some advantages for both you and the mortgage holder, even though it still hurts your credit rating.

Definition

A short sale is a transaction in which your mortgage holder agrees to accept a certain amount of money as paid in full for your loan, even though it is less than what you actually owe. You benefit because you get out of a loan that you cannot afford, and your bank avoids the time and expense of foreclosure and keeps the house steadily occupied. You may be eligible for a government program that helps you financially if your mortgage is delinquent and you choose a short sale.

Approval

Mortgage lenders are most likely to approve short sales when your payments are already delinquent, because late payments indicate financial problems that can lead to foreclosure. Many lenders prefer to lose some money in the short sale rather than foreclosing and reselling the property themselves, which can be a costly process for a lender. You need to prove financial hardship, even though your payments are late, by providing information on your income and expenses. Some banks take as long as seven months to approve short sales.

Effects

Late mortgage payments hurt your credit rating badly because they are part of your overall payment history. Thirty-five percent of your credit score comes from that area, the FICO scoring company advises. The short sale itself is nearly as bad as an involuntary foreclosure or voluntarily turning your home over to the lender because it still marks you as a high-risk borrower with serious financial problems. Your credit score can drop as much as 200 points, depending on the status of your other accounts, a FICO spokesman told The Wall Street Journal.

Considerations

Your short sale might fall through, and you might end up in foreclosure because of your prior late payments, if your potential buyer does not wish to wait for your bank's approval of the deal. You may face some tax liability if the short sale goes through because the forgiven part of your loan might be considered income by the IRS. Get a written agreement from your lender that it will not hold you liable for the difference between the sale price and your loan balance. Some mortgage companies pursue former home owners for the deficiency amount after the short sale is completed.