Image: House for sale © Ocean, Corbis

Arranging a successful short sale takes a lot more effort than simply letting your home slide into foreclosure. So why do your credit scores have to suffer so much?

That’s the question people typically ask when they learn that the leading credit scoring formula, the FICO, treats short sales and foreclosures as essentially the same, said Barry Paperno, the community director for Credit.com.

A short sale is when a lender agrees to accept less than the homeowner owes on a mortgage. Someone with an excellent FICO score of 780, for example, could see 140 to 160 points chopped off that score with either a foreclosure or a short sale, according to the company that created the score. Recovery from either blow could take seven years.

The issue of this major credit-score dip is affecting more people as banks approve more short sales. In fact, there were more short sales than sales of bank-owned homes in the third quarter, according to real estate research firm RealtyTrac. Sales of so-called pre-foreclosure homes jumped 22% compared with the same period a year earlier, and short sales made up 65% of those sales, RealtyTrac said. Short sales of homes that haven’t entered the foreclosure process also rose 22% compared with the third quarter of last year.

Short sales can benefit both lenders and borrowers:

  • Short sales can be better for lenders, since the sale price may be more than the home could fetch after foreclosure. Also, they allow lenders to avoid the often long and costly legal process of eviction.
  • Short sales have benefits for borrowers, too, since a short-sale agreement can prevent a lender from suing a borrower over unpaid debt.  These so-called deficiency judgments are otherwise possible after a foreclosure in many states.

Short sales still aren’t easy. Agreements can take months to negotiate, and many fall through. A successful deal usually requires a tenacious and persistent homeowner.

So, shouldn’t that behavior be rewarded?

There you have the crux of the problem. The FICO formula is, essentially, amoral. It wasn’t built to reward or punish, said Frederic Huynh, FICO’s senior scientist. Instead, he said, it was constructed to predict the likelihood that a borrower will default on a credit obligation within the next two years.

Interestingly, FICO formula creators didn’t have a lot of experience with short sales when they decided to treat them the same as foreclosures, said Paperno, who worked at FICO for 16 years before joining Credit.com. Until recently, short sales were relatively rare.

But FICO published research this summer, based on analysis of credit report data from people who fell behind on their mortgages from 2007 to 2009, which confirmed that most people who have a short sale or a foreclosure on their records later default on at least one other credit account.

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Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.

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