12/19/2012 5:45 PM ET|
Why short sales trash your credit
Even when you try to do the right thing by avoiding foreclosure, the credit agencies are unlikely to notice.
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.
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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Some parts of this article are grossly inaccurate.
1. The hit on your Credit comes not majorly from the sale. Rather It comes from the delinquency reporting’s on your Credit report, while waiting for the sale to go through
2. While it reports on your Credit report the same, a short sale is treated like a settlement and drops off after three years. A foreclosure is far worst. It stays on your Credit report for the full 7 years as well as the delinquencies.
3. If you stay on top of your other Credit Cards and other loans three years is about the time it will take to recover your Rating. This means; Staying below 50% credit utilization, using your Cards and paying in full, and no other delinquencies on any other Loans, or Credit Cards.
One Big Truth in this article
1. Stay on top of your lender. This means, double and triple checking that they have everything they need to complete your sale in a timely manner. Call them, write them and stay on top of them.
Also Keep records of who you spoke too. Dates, Times, content of the conversation, try to make the call from a Cell phone or have your company track the calls so that if subpoenaed you have the written documentation to support your claim.
If your short sale is occurring due to Underemployment or extemporaneous bills, once you stop paying on your mortgage, use that time to pay off or pay down your other debt.
Once again. WRONG WRONG & WRONG AGAIN. We had a short sale. It took months to go thru. They practically GAVE the house to the borrower. In fact they "sold" the house to him for $70,000 less than what we paid for it.
The bank wouldn't even consider a modification for us! We were being punished for getting behind in payments & we knew it. What was hard to swall ow was we got behind because my husband got hurt at work & we couldn't control the snail speed of Workman's Comp.
FICO believes people who have short sales will DEFAULT again w/credit cards w/in 2 years. WRONG! we paid off our credit cards & have NOT EVEN THOUGHT about getting anymore! We are DONE w/that song & dance.
Thanks alot FICO we tried to do the right thing w/a short sale & not foreclosure & got screwed anyway!
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