Ardell posed a question on her last post about credit scoring that I’ve been meaning to address here at Rain City Guide on how credit scores are impacted by short sales or foreclosure. When I was speaking at the Mortgage Girlfriends Mastermind Retreat in Scottsdale this summer, I had the opportunity to meet Linda Ferrari, a well known credit expert and author of “The Big Score – Getting It and Keeping It” (a book I highly recommend everyone read).
According to Linda, “a foreclosure can drop a credit score 50-250 points (this includes points all ready lost to delinquent payments). The difference in point loss depends on how many points someone has to lose in the payment history factor of his or her credit report. Thus is someone has a 750 credit score and they opt to foreclose, their score could drop 250 points. However if someone has a 500 credit score, they may only lose 50 points for the same derogatory.”
It hardly seems fair to me that someone who has established excellent credit and they are faced with a huge financial hardship, they’re penalized on a greater scale simply because they have “more to lose” (reminds me of our income tax system)! With a foreclosure, you can expect to wait about 5-7 years to purchase your next home (based on current guidelines) assuming a mid-credit score of 680 and a 10% down payment for conventional financing.
A deed in lieu of foreclosure may impact credit scores the same as a foreclosure depending on how it is reported to the credit bureaus–they don’t have to report it as a foreclosure…if they do, the credit will be scored as such. Here’s what Linda recommends you try negotiating how the deed in lieu is reported on your credit with the lender in preferred order:
Paid As Agreed. Credit scores will have already dropped over 100 points due to default in payments; however, if reported as Paid As Agreed, the borrower will be able to purchase another home in a shorter time period. Paid Settlement. Credit scores could drop 75-100 points in addition to the points already lost for delinquent payments. Foreclosure. Credit scores could drop 100-150 points in addition to the points already lost for delinquent payments.
One advantage of a deed in lieu of foreclsoure is you may be able to purchase a home, if you so desire, a minimum four years afterwards with 10% down payment, based on current guidelines.
A short sale is potentially the least damaging to your credit scores assuming you’ve been able to make mortgage payments on time. According to Linda, credit scores may drop from 50-150 points (depending on what else is going on with your mortgage and credit history). You may also be able to buy a home quicker using this route. Linda Ferrari writes on her blog why you may not want to consider using a short sale as an option should you be in financial distress.
FHA may allow borrowers who have lost a home due to short sale, deed in lieu or foreclosure a little quicker than conventional financing–around three years depending on various factors. Extreme extenuating circumstances may allow for a shorter time period. Again, this is current guidelines. I wouldn’t be one bit surprised to see FHA change this guideline to be more in line with conventional financing.
You have to keep in mind that credit scoring is accumulative, everything is factored to come up with those three scores that are suppose to reflect your current credit. The only real good news about credit scoring is that your scores are temporary–they are changing constantly. Pay down a credit card, establish good payment history on your installment loan and your scores will improve over time.
Rhonda:
Good job, and thanks for the link!
I would add that maintaining, or increasing your available credit is important to your credit score as well.
I’ve had some clients recently get sucker punched by dropped credit limits on accounts with balances.
Thanks, Roger. One point that Linda makes in her book (and her presentations) is that it’s never too early to start rebuilding your credit.
I see from the link “why you may not want to consider using a short sale as an option” that The Mortgage Forgiveness Debt Relief Act Of 2007 ends this year. Any word on this being changed to affect people going through a short sale in 2010? Ours is closing in January…(after being in the works for 7 months!!)
thanks
This is an issue that people are discussing a lot recently… Do you believe that there is one option that really wins? It seems to be a fight against both
Tony, neither option is easy…and every option needs to be weighed out based on that individual’s personal scenario. There are a lot of factors to be considered.
I recommend contacting an attorney to review options before deciding which path to take if someone is in this position.
Fannie Mae recently updated their guidelines with a 7 year waiting period on foreclosures unless there are documented extenuating circumstances:
Fannie Mae has issued Announcement SEL-2010-08, Underwriting Borrowers with a Prior Foreclosure, to modify the waiting period that must elapse before a borrower is eligible for a new mortgage loan after a foreclosure. A seven-year waiting period after a prior foreclosure will apply for all borrowers, unless the foreclosure was the result of documented extenuating circumstances, which requires a three-year waiting period with additional eligibility requirements.
Loan approval for the next home purchase following a foreclosure is still subject to other qualifying matters (such as credit)
Just learned that USDA’s waiting period following a short sale or foreclosure is 3 years…thought I’d share that info here.