Recently I read an article about not only changes being made
in the mortgage industry, but also how those potential changes might affect credit
scores. Since the article lists some
credit “facts”, I feel obligated to address it further. The article is short so I have listed it here
and will follow up with a few opinions after:
Nondelinquent Borrowers Soon to Be Eligible for Short Sales
Daily Real Estate News | Wednesday, October 24, 2012
Mortgage giants Fannie Mae and Freddie Mac have issued new
rules, which will take effect Nov. 1 that will allow short sales for underwater
borrowers who have never missed a mortgage payment. Previously, Fannie and
Freddie allowed only home owners who had missed payments to qualify for a short
sale.
Eligible borrowers under the new rules will need to show a
hardship to qualify for a short sale, however. Hardships may include
unemployment or a death of a spouse.
Inman News points out one potential flaw to the new rule,
however: The nondelinquent home owners who undergo a short sale will likely
take just as big a hit to their credit score than if they had missed loan
payments and gone into a foreclosure.
“Under current national credit reporting practices, those
nondelinquent borrowers are likely to be treated the same for credit scoring
purposes as severely delinquent owners who go to foreclosure after months of
nonpayment, or who simply toss back the house keys and walk away in strategic
defaults,” writes Ken Harney for Inman News.
Credit agencies use no special coding to indicate that a
short sale was without delinquency. Therefore, home owners could see their
credit scores drop 150 points or more after the short sale.
However, officials at the Federal Housing Finance Agency,
which oversees Fannie and Freddie, told Inman News they are “in discussions
with the credit industry” to explore ways to fix the credit score problem for
those who haven’t missed a payment but undergo a short sale.
The good news is that when the new rule change goes into
effect, this will now give people an even greater incentive to take this course
of action rather than just allowing the property to be foreclosed on.
The bad news is a few of the credit facts listed in this
article are wrong or at best misinterpreted.
With all due respect to Mr. Harney, who is a much esteemed writer, I
believe the source of where some of his credit information came from was a
little off, specifically paragraph 3 and his quote following that in paragraph
4.
To completely understand the debate about short sales vs.
foreclosures and more specifically the impact on the FICO score we need to
understand a few things.
First -what happens
prior to the closing/sale date?
With a foreclosure we know that the person will have
multiple late payments listed on the credit report for that account. With a short sale (especially with this new
rule) there doesn’t have to be any late payments. This is great news because the
absence of 30, 60, 90+ day late payments on an account is better for your FICO
score than if those were present on the account history. One of the biggest arguments that people used
to have is that it was basically impossible to get a short sale negotiated
without being delinquent first. Now with
this new change that issue should be eliminated.
For this reason, if a
person does not become delinquent on the mortgage prior to the short sale being
completed this action would be better for the FICO score than a foreclosure.
Advantage- short sale
Second- what happens
after the closing?
When there’s a foreclosure the account will be listed as
such or it will say “charged off account.” Any derivative of this is bad and
will hurt the FICO score. With a short
sale the article is correct; there is no special way that a lender can mark the
account as a short sale. Since that is
not an option the lenders have the choice of how they report it. Most commonly lenders report it as “settled
for less than full” which in the eyes of your FICO score all means the same… it
is bad! With that being said, since a short sale is not an option for credit
reporting, the one wild card that can come into play is if the lender just
simply marks the account as “paid”. If
this were to happen it would be much better than being reported as a
foreclosure.
Advantage- short sale
The last part of this debate hasn’t been covered. Not only
is the FICO score measuring how
delinquent someone’s account is, it’s also measuring the time since that incident. Meaning the older that negative is, the less
it hurts your score. With a short sale
you can help to speed up the process, which will help an individual’s FICO
score recover quicker.
Overall if this new rule does in fact come into play it is a
positive thing for struggling homeowners that need to get out from under a
property they can no longer afford. Keep
in mind homeowners also want to do everything they can to lessen the credit
score damages that will become associated with any of these actions.
