How do I repair my credit after a short sale?

By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, I had excellent credit before a mortgage modification "counselor" advised me not to make my payments so I could qualify for a loan modification. One year later, the home was short-sold after I was denied a modification. I need to fix my bad credit so a mortgage lender will finance a new home. What should I do and how long will it take? - Marcia, Los Angeles, Calif.

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Dear Marcia,

You were advised to stop paying your mortgage in order to convince your lender that you were at risk of "imminent default," which is one of the criteria you have to meet before being granted a mortgage modification under the Home Affordable Modification Program (HAMP).

Unfortunately, it has proven nearly impossible for homeowners to apply for a mortgage modification without suffering credit damage. Missed mortgage payments do severe damage to credit scores, as does a short sale. And mortgage lenders are less forgiving of late payments on a home loan.

Short sale and your credit report

The short sale itself does no damage to your credit; it's how the lender reports it that matters. In fact, how the sale is to be reported is one of the terms up for negotiation when you work out a short sale. Some homeowners are able to negotiate a "paid as agreed" notation by absorbing some of the lender's loss on the sale. Other terms that may be used are less forgiving, such as "account settled" or "creditor settled for less than amount due" or the worst notation of all, "charge off."

The amount of time it will take to rehabilitate your credit score depends on how many mortgage payments you missed and how the sale is reported to the credit bureaus.

Solving your mortgage credit problems

You do have a couple of things in your favor. First, you previously had a good and extensive credit history and you continued to pay everything but your mortgage on time. So the short sale will hurt you less than they would someone with a minimal or troubled past.

Second, you have avoided getting a foreclosure on your record, which would keep you from getting almost any kind of mortgage for at least three years. So your main strategy is to simply continue to put good credit experience between you and your missed payments:

  • Make sure all of your other debt payments are always made on time, and reduce any debts you have as much as possible.
  • Continue to use your credit cards but don't carry a balance from month to month.
  • Check your credit report every six months to make sure that everything is being reported correctly and to see how your scores are improving.

Once you have a score that exceeds 620 or so, you may be eligible for FHA financing, especially if you have compensating factors like a down payment that exceeds 3.5 percent, a healthy debt-to-income ratio, money in the bank and conservative use of credit. You can think about applying for a conventional loan when you have over 20 percent down or credit scores over 700 -- or a few years have passed since your mortgage payment debacle.

However, at least you were able to avoid having a foreclosure on your record.

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