Sunday, October 4, 2009

Demystifying Credit Scores: Pt 3 How Foreclosures and Short Sales Affect Your Score

This is the third of a series of fiv mini posts on Demystifying Credit Scores.

Please be sure and read through the other posts, too.


Short sales are slightly less damaging than a foreclosure to your credit score.... for about the first 12 months after its occurrence. 

  • If you are paying as agreed up to the short sale, for that duration of time, the loan is rated PAID AS AGREED, which is good.

  • It is possible, sometimes, to stay current on your mortgage and to complete a short sale. 

  • Once either the short sale or foreclosure is completed, both accounts are reported the same: PAID DEROGATORY, and therefore will affect your score the same from a numerical standpoint.  Dave used the analogy that it doesn't matter really whether you ran off the cliff or walked off the cliff, the point is you still went over the cliff.

  • After the short sale or foreclosure, the major difference in how it will affect your score relates to the balance that shows as unpaid (since balances for outstanding credit are a big part of the scoring model).  Short sales, as forgiven debt, will sometimes be reported with a zero balance. But, balances are only considered for 12 months.  So, one year after either a short sale or a foreclosure, the rating and numerical impact are the same.  Refer again to the jumping over the cliff analogy.

    Foreclosures can also become public records (this varies state to state).  From that standpoint, foreclosures can take a dramatically worse toll on your credit report than a short sale - as public records are weighted very heavily.  Here is where it can REALLY matter.
  • Accoring to a November 29, 2009 article by Jeremy Simon published on, FICO has just revealed examples of point score drops for certain credit events, as follows:
    If your previous credit score was 680: A Foreclosure would drop your score 85 to 105 points.  A Bankruptsy would drop your score 130 to 150 points. If your previous credit score was 780:       The Foreclosure's impact would be a 140 to 160 point decline. The Bankruptsy's impact would be a 220 to 240 point reduction. For examples of how this could actually COST YOU MONEY, see the post "So What".
Please note here that we are referring to CREDIT SCORES!  When it comes to buying a house after a short sale or foreclosure,  it is up to the lender as to how to underwrite these things.  Chances are that a short sale will be considered more favorably than a foreclosure during a loan application process. 

It's hard to know where the future of credit scoring or loan applications will go as we move past this part of our history.  But we can rely on past experiences and common sense to help us know what to expect.

Prior to this period in our history, we've been through other periods where people had many foreclosures or people did deed in lieu of foreclosure transactions with their bank.  I experienced many lenders who said, even if the person would otherwise qualify for a 100% loan, if they had a foreclosure EVER they could not receive 100% financing on a property. 

In fact, my dad was business partners with someone who had a previous foreclosure on his record.  The business partner had a very good credit score at the time, and had a current mortgage for a principal residence that had nearly 20 years of being in good standing.  But, after a couple of times of being told by lenders the partnership was better off not including him on loan applications, they just stopped doing it - and so my dad became fully responsible for all the business debt.

This type of underwriting attitude is likely to continue into the future, even as this period gets further and further behind us.
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