Short Sales and how they impact the Fico Score
With the economy in distress and mortgage defaults at a record high this question has come up often among professionals and consumers. I have held off on writing about this topic because of so many conflicting answers uncovered in my search for the facts.
What is a Short Sale (for those of you who are not familiar with its definition)?
A short sale happens when a lender agrees to accept less than the amount owed against the home because there is not enough equity to sell and pay all costs of sale.
For example: John and Mary Smith owe $300,000 on their mortgage to the Lender. They have an offer of $100,000 from a buyer on their home. After careful review of the facts supplied (and usually a long time) the bank accepts $100,000 as full settlement on the mortgage and forgives the $200,000.
The government also forgives the taxable debt they would owe on the $200,000 of income John and Mary received from the Short Sale. Before the Real Estate bubble burst the government would have viewed the $200,000 forgiveness of the Lender as income to John and Mary and they would have been 1099 for it.
When it comes to the Fico Scores the truth is a short sale is just as bad as a foreclosure in terms of your credit score. Here is what Fico says:
“The common alternatives to foreclosure, such as short sales, and deeds-in-lieu of foreclosure are all “not paid as agreed” accounts, and considered the same by your FICO® score. This is not to say that these may not be better options for you from a financial perspective, just that they will be considered no better or worse for your FICO score.
If you are considering bankruptcy as an alternative to foreclosure, that may have a greater impact to your FICO score. While a foreclosure is a single account that you default on, declaring bankruptcy has the opportunity to affect multiple accounts and therefore has potential to have a greater negative impact on your FICO score.”
The information I have gathered from FICO states that the higher your credit score the greater the drop. It doesn’t matter if you have either a foreclosure, a short sale, or a settlement the score will see it as the same negative impact.
It should be clear that a short sale is listed on the credit report as a “Settled for less than full balance” or “Settlement accepted” and there will be NO mention of “short sale” anywhere. Your score could drop anywhere from 70-150 points. If there were late payments prior to the settlement it could drop an additional 80-150 points. Fico states that the higher your score is before the delinquency the lower it will drop when the settlement is updated.
There are other variables that impact the credit as well.
Is the consumer late on other accounts? If there are late payments on revolving credit (credit cards and lines of credit), installment loans (student and cars), or other mortgages (multiple mortgages) the score could be even lower.
How much credit does the consumer have? If they only have one credit card and a mortgage it could reflect differently than someone with 10-15 different good accounts. It is hard to say exactly what number amount a score will drop for each person who has the same negative. Every credit report is different since every credit profile is unique to the individual it represents. The facts are clear that the score will drop significantly and it can’t be a good thing for your credit Fico score.
We have seen this same outcome when it comes to late payments for consumers as well. When we see just one 30 day late payment on a score of 750 you can see a drop of sometimes 70-100 points. When a consumer has been late many times on many items and their score is in the low to mid 500 range it may not drop much more when new charge offs, judgments, and or collections are updated. The score usually lingers in the same low area. It seems you can only go so far down in score once you begin to default. Each late payment, collection, charge off or bankruptcy is not considered 70-100 points once your score has taken a great plunge.
When it comes to getting another mortgage in the future there is a difference in from going to foreclosure and a short sale. This should be discussed with your Mortgage Professional. You may have to wait longer to be approved for a mortgage from the date of a foreclosure depending on the type of loan you are applying for.
Remember that no credit situation is beyond hope for a brighter future. All credit can improve and be excellent no matter how bad it might be now. Once the financial stress is over we can begin to raise your credit score and educate you on your part in the process.
Copyright ©2009 North Shore Advisory Inc.
