The cost of skipping a house payment
A new study shows just how much a missed mortgage payment, a short sale, and other credit sins affect a FICO score and how long it takes to bounce back.
This post comes from Marilyn Lewis at MSN Money.
Some of us have a hard time taking credit reports seriously. You were late on a house payment. So what? If you pay it eventually, what's the big deal? It's not the same as defaulting on your mortgage.
Crazy as it may seem, one skipped payment isa huge deal. And credit reports wield a great deal of power.
"A person's credit score has become the only thing that matters anymore to the banks and other institutions that underwrite mortgages," wrote The New York Times' Joe Nocera last year, in an article about the tyranny of credit scores.
If you're easily shocked, you may want to cover your eyes for the next revelation: Credit scores gained prominence during the bubble because Wall Street wanted to identify poor credit risks -- not to avoid them but to package the lousy loans into securities that sold for higher prices. The riskier the loans, the higher the yields on those securities.
You can't be cynical enough these days, can you? Nocera writes:
They pushed lenders to make loans to people with low credit scores, which became shorthand for risky loans.
In the aftermath of the bubble, credit scores have remained shorthand for a borrower's creditworthiness -- except that now borrowers need to have high credit scores instead of low ones. And yet, credit scores are no more accurate than any other risk model.
The real world
But we digress. We must live in this world -- or try to -- so let's see what happens when you let your credit score get banged around.
FICO, the company whose credit scoring system is used billions of times a year worldwide, recently measured the effect of skipped mortgage payments on credit scores and calculated how long it takes to recover.
Interestingly, a lot depends on what your score was to begin with. "In general, the higher starting score, the longer it takes for the score to fully recover," says FICO.
The researchers considered three hypothetical mortgage-holders:
- One with a high 780 (of a possible 850) FICO score.
- One with a decent 720, including a couple missed credit card payments.
- One with a low but not awful 680 with a history of struggles paying credit cards or a car loan.
The report has charts showing the damage and time needed to recover for:
- Being 90 days late on the mortgage.
- A short sale (in which the lender lets you sell your home for less than the mortgage balance, absorbing a loss).
- A deed in lieu (a defaulting owner surrenders the deed to the lender).
- A bank settlement with no deficiency balance (the bank loses no money).
The conclusion: Don't pay your mortgage late, even by just 30 days:
- One 30-days-late payment shaved 90 to 110 points off the 780 score, dropping it to the 670-690 range.
- The 720 score dropped 70 to 90 points, to the 630-650 range.
- The 680 score fell 60 to 80 points, to 600-620.
It seems odd, doesn't it, that the highest scores -- the most reliable borrowers, in theory -- pay the biggest penalty.
Also, "in general, the higher starting score, the longer it takes for the score to fully recover," the report says. Post continues after video.
The most damaging of all these events are foreclosure and bankruptcy.
- 140 to 160 points off the 780 credit score and seven years to recover.
- 130 to 150 points from the 720 score and seven years to recover.
- 85 to 105 points from the 680 score and three years to recover.
Bankruptcy -- worst of all -- takes:
- 220 to 240 points off the 780 credit score and seven to 10 years to recover.
- 175 to 195 points from the 720 score and seven to 10 years to recover.
- 130 to 150 points from the 680 score and five years to recover.
The study, posted on FICO's Banking Analytics Blog, provoked intriguing comments from readers, some of whom appear to have mortgage expertise.
FICO score is not the only consideration when you are comparing foreclosures and short sales. You can qualify for most home loan financing within 2-3 years after a short sale. It can be 3-7 years after a foreclosure. In addition, the current standard residential loan application asks whether you have EVER had a foreclosure. It does not ask about short sales. So if you had a foreclosure, 15 years from now, you would have to say "yes" to that question, or risk a claim for loan fraud.
This article does not mention the impact on your job. If you complete a foreclosure and you have to pass a security clearance, you will loose your job. In this case a short sale is a better choice.
We just got notice from a Very Large bank that has a large foreclosure inventory. They are going to be running credit reports on their Broker/Agent network and if the Broker/Agent has lost their home to foreclosure or short sale, they will no longer be able to handle the assets (foreclosed homes) for them.
Joanne Gaskin, one of the authors of the FICO blog, responded. About 35% of your FICO score is based on your payment history, she said. "… our (FICO) model focuses on three dimensions: recency of the nonpayment, severity (how long overdue is the payment), and frequency (how many accounts have been reported delinquent)."
Reader "Howard Bono" predicts that FICO -- and lenders -- will have to become more forgiving of defaults. "You cannot eliminate 15 million former homeowners for 7 years and expect the housing market to recover and the banks to stay solvent."
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