While there are no guarantees, a short sale is generally better than a foreclosure when it comes to how lenders will view your credit in the future. The real pivotal factor is in how you handle matters before, during and after the short sale.
Lenders, including banks or other financial institutions that hold mortgages, have the right to report to credit bureaus as soon as a debtor goes 30+ days behind on a mortgage payment. When late payments are reported to any or all of the three major bureaus, credit is adversely affected.
The more late payments are reported, the worse the effect is. Most people who end up in foreclosure have multiple 30, 60, and 90+ day late payments due on their reports. This is what causes a lot of the lasting damage, as each payment missed adds another ding to the credit report.
If you know that you are going to be unable to make your payments soon, moving quickly to achieve a short sale can help minimize the damage. If you can keep making payments right up until the short sale goes through, you will likely have one of two reports on your credit: “paid in full for less than the full amount” or “settled.”
If you don’t have the separate dings of late payments in addition to the notification settled amount, your credit score may not be as hard hit as you would expect and you may be able to start rebuilding your credit fairly quickly.
In contrast, if credit bureaus receive reports of a long series of late or missing payments followed by the notice of “foreclosure”, your credit score is much more likely to take a hard hit and obtaining credit may be near impossible for a number of years.
Of course, each lender has a different way of reporting, and credit scores can depend on a wide variety of factors – of which your home loan may only be one. However, experts generally agree that if a choice is to be made between foreclosure and a short sale, the latter is not as bad as the former and is easier to recover from.