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How Do Short Sales, Loan Modifications and Foreclosures Impact Your Credit Score?

September 10th, 2009 · 7 Comments · Credit Bureaus and Scores, Mortgages, Real Estate

by Kristy Welsh

(Last Updated On: February 13, 2017)

I attended a class at my real estate brokerage last week dealing with short sales and other types of “distressed” properties. With the market (at least in the Phoenix area) now comprised of over half short sales and/or bank-owned properties, it is imperative for real estate professionals to be well trained and knowledgeable in order to advise clients who may enter into one of these transaction types.

While listening to my instructor (with my mind drifting elsewhere as does happen in classes such as this), my ears perked up when he spent a few minutes addressing (his version) of how a short sale versus a loan modification is shown on your credit report. According to him, either of these actions will result in an approximate 100 point loss on your report. A short sale will specify “paid in full, as agreed by lender, not as originally agreed,”  while a loan modification (or “work-out” plan) will look something like “loan modified, at buyer’s request, not as originally agreed.”

Everything I’ve read to date on the subject generally suggests that a short sale (where your lender takes less than is owed on the home and writes off the difference) will have less of an impact on your credit score than a foreclosure or deed-in-lieu of foreclosure (where the borrower ‘gives back’ the property to the lender without a foreclosure proceeding). But a recent article I came across by Greta Guest (Detroit Free Press) suggests this may not be the case. Guest’s article quotes John Ulzheimer, president of consumer education for Atlanta-based Credit.com, who spent seven years as an employee at Fair Isaac. According to Ulzheimer,  “The credit bureau sees those all as equal,” adding, “They are all essentially in the eyes of FICO a major delinquency.”

According to the article:

“A short sale is not reported on the credit score. A short sale shows up as a settlement, a charge-off or a foreclosure process started and all are major delinquencies,” Ulzheimer said.

What matters more is the state of the person’s credit when they are defaulting on their mortgage. The higher the score, the greater the damage, he said. For example, someone with a very good score of 750 and above could see it go down to 575 to 600 overnight once a settlement is recorded.

“Someone out there is passing along a rumor that a short sale is better for your credit than a foreclosure or even a deed in lieu of foreclosure,” he said. “All are equal in the eyes of FICO, and will remain on your credit report for seven years”.

While the reported source in the article seems to be one that would be trustworthy, it is difficult to find any firm verification from Fair Isaac (the developer of the FICO Scoring model) due to the proprietary nature of their system. But there are additional considerations that may make a short sale a better solution, namely the ability to qualify for a new loan. For instance, if a consumer has had a foreclosure or deed in lieu of foreclosure action in the previous five years, they will be unable to qualify for a Fannie Mae or Freddie Mac backed conventional loan. However, these time periods may be shortened to as little as 2 years in some cases if you can prove “extenuating circumstances” such as job loss or medical conditions). However, the consumer still may not have sufficient credit or income to qualify for the loan, thus this may or may not be a relevant consideration.

So what is the moral of this story? Distressed homeowners out there need to really do their research to determine which option will be the best alternative for resolution of their situation. With so much variation in the information being presented on the web and media, it is vital to confirm the source of your information and get a second opinion.

Has anyone gone through one of the distress situations mentioned above that can share how their credit score and report was affected? If so, leave a comment!

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7 Comments so far ↓

  • Cindy

    As a post-script to this blog post, I read this article today which centers around the Vantagescore scoring system (a range of 501 to 990) – here is a snippet from the article, which also seems to support the notion that short sales are equally damaging to your credit score:

    According to VantageScore researchers, short sales can trigger big drops in scores. Sarah Davies, senior vice president of analytics, said a homeowner who previously had an excellent score of 862 might plummet 120 to 130 points immediately as the result of a short sale.

    http://www.connpost.com/ci_13306955?source=rss

  • Randy Mitchelson

    In August we published an article on this subject.

    The impact of foreclosures on credit scores is a recurring question we hear and there is conflicting information published on the Internet. First American Credco, a credit reporting agency recently published a definitive summary of their findings. The biggest myth that the report resolved was that a short sale would have a lesser negative impact on a credit score than a foreclosure. Whereas in theory this may make sense, the reality of a short sale situation makes it likely to be just as bad as a foreclosure.

    In most cases, a short sale will also entail a public record, like a legal action by the lender against the borrower or a special code called MOP8 (method of payment) attached to the short sale tradeline. Both of these items would make the short sale have a similar impact on the credit score as a foreclosure. Also, if a homeowner is in default on their mortgage, chances are that they also have late payments on other accounts like credit cards, so the score would reflect all of the data, not just a single item.

    Although a specific point value cannot be assigned to a foreclosure or short sale, it is safe to assume that a credit score will drop anywhere from 100-300 points depending upon the other factors considered. If a foreclosure is the only blemish amidst a long history of perfect credit, then the drop will be less. If the short sale is just another in a series of late payments on other accounts over the years, the drop will be more severe.

    Consumers in this situation should immediately take steps to begin rebuilding their credit using credit building products like secured credit cards and CD Secured loans.

  • colammy

    Interestingly, we have always had an 800+ credit score. Beginning in January ’09 my husbands salary was radically reduced, we immediately contacted our lender in hopes for a loan modification or refinance. Six months later, with no help from our lender, we missed our first payment in 13 years of owning a home. Now we are 60 days behind and finally on a three month trial forbearance and waiting for our final loan modification workout solution.

    Yesterday I decided to check our credit scores, mind you we have a flawless history, not only with our past mortgages but also credit cards and auto loans. However, being 60 days late, and on a reduced payment plan, every month our lender shows that we are 30 days late and the result has been a 175 point drop in our score.

    We are not in foreclosure, nor have we been issued a notice of default, nor a short-sale.
    In efforts to stimulate the economy and over come the vast mortgage crisis, our government officials really need to address this issue. If consumers are hit this hard, they will not be able to get loans for years to come, and our economic situation will get worse.
    I take responsibility for our situation and expect that our credit would ultimately be effected – but I don’t feel a 175 point drop is justified; considering the six month warning to the lender and our outstanding past payment history.

  • Short Sale

    There can be no bigger ambiguity in short sales than the one regarding credit scores. With all lenders acting differently in different situations its almost impossible to tell factually what will happen.

  • Newport Coast Homes

    In a short sale, the lender accepts less than the mortgage debt when the property value has declined. “A short sale will prevent foreclosure,” says White. “However, if it takes place after foreclosure was initiated, the foreclosure and the related delinquency in payments will be reflected on the credit report.” The only way to protect the credit score fully is to maintain monthly payments until the house is sold.”

  • chrissy

    Under penalty of perjury you certify that:
    1) the sale of the property is an “arm’s length” transaction between parties, who are unrelated and unaffiliated by family, marriage,
    or commercial enterprise;
    2) there are no agreements or understandings between you and the Buyer that you will remain in the property as a tenant or later
    obtain title or ownership of the property;
    3) neither you nor the Buyer will receive any funds or commissions from the sale of the property

  • Holly Jewell

    The Treasury Department designed a new credit reporting code specifically for Mortgage modifications. The new “CN” code signifies a loan modified under a federal government plan. It will have no impact on credit scores in the near future.

    Many lenders are incorrectly using the AC code which signals that a consumer has made only a partial payment. This is incorrect and negatively impacts your credit. I would recommend disputing this on your credit report or you can contact me to handle that for you through my repair services at http://www.homedestinations.net\

    Also check out this article: http://bucks.blogs.nytimes.com/2010/01/05/how-loan-modifications-impact-credit-scores/

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