I work with home sellers every day that are facing a distressed sale of their home... all of them have similar questions about how foreclosure or short sale can affect your credit scores. It depends on what your financial picture is before and during your distressed sale and if you are having a foreclosure or will you short sale your home. In either case, it will impact your credit. How much depends on the type of distressed sale.
If you allow your home to be foreclosed or if you sign a Deed in lieu of Foreclosure. Both of these solutions affect credit the same. Home owners will take a hit from 200 to 250 points on their FICO score. This means if their FICO score before foreclosure was 680, it could dip as low as 430. A home owner who wants to buy another home after foreclosure will end up waiting about 60 months before a lender will offer any kind of interest rate that makes sense for a federally backed loan as well as a conventional. During that time you must work hard to improve your credit score. It is also important to know that any other liens beside the first mortgage (that is the second mortgage or HOA lien as an example) are wiped out by the foreclosure and will show up on your credit report.
If you choose to do a Short Sale on your home: The affect of a short sale on a home owners FICO credit report will be to reduce it from 150 to 200 points. Your credit score could be sent negative by as little as 80 points from the FICO score before financial problems started if there are no late payments involved. This however, would be unusual in my opinion since most of the Sellers in a short sale process have stopped making payments because they have lost their earning ability sufficient to maintain payments or they have been told that they will need to be late on payments by the lender for them to consider a short sale. When the short sale is complete the sale will typically be reported on the credit report as a "debit paid off at less than full value" and is much less damaging than a foreclosure. It can also simply show up as the loan was paid off, it is all up to your lender. In a short sale all liens must be accounted for and be a part of the negotiation process to be released.
Deficiency Judgments: The bad news is a home owner could be subject to a deficiency judgment for the difference between the loan amount and the amount paid. In Arizona, ARS 33-279 section A (shown below) will protect many home owners from a deficiency in the mortgage balance. Where a owner is not protected, the lender has sole discretion whether to pursue a deficiency judgment. In many cases even if a Deficiency Judgment is allowed it not be pursued by the Mortgage Company, it depends on the mortgage company review of your financial situation. If a home owner is trying to decide whether to let a home go through foreclosure versus attempting a short sale, being able to reestablish your credit faster and avoiding a "foreclosure" is the main advantage to doing a short sale.
ARS 33-279 Section A - "Except as provided in subsection B, if a mortgage is given to secure the payment of the balance of the purchase price, or to secure a lona to pay all or part fo the pruchase price, of a parcel of real property of tw0 and one-half acres or less whcih is limited to and utilized for either a single one-family or single two-family dwelling, the lien of judgement in an action to froeclose such mortgage shall not extedn to any other property of the judsbement debtor, nor may general execution be issued against the judgement debtor to enforec such judgement, and if the proceeds of themortgaged real property sold under special execution are insufficient to satisfy the judgement, the judgement may not otherwiese be satiffied out of other property fo the judgement debtor, notwithstanding any agreement to the contrary. "
Deed-in-lieu of Foreclosure:
The deed in lieu of foreclosure allows the home owner to be released from most or all of the personal indebtedness. It can help to prevent public notoriety of a foreclosure proceeding. If you have been unable to make your monthly mortgage payments and have also been unsuccessful trying to sell your home at the market value, this form of foreclosure may be what is necessary to get you back on track. This procedure allows you to transfer your property voluntarily to your lender or Mortgage Company. The debt or deficiency maybe forgiven in Arizona depending on your specific situation. It is a negative strike on your credit rating and may be less harmful than a mortgage foreclosure. Typically your Mortgage Company will require that your home has been listed with a Real Estate Agent for at least 90 days and there are no other liens on the property for them to approve you. Some Companies may also require that the property be vacant. This type of foreclosure will typically take 45 to 90 days to complete.