In Florida today, as well as around the country, there are home owners who are financially unable to keep up their house payments. Unemployment, unexpected medical bills, death, divorce — there are any number of reasons why a mortgage is simply too burdensome to bear for Floridians today. Responsible people are having to deal with harsh realities. It’s an all too common problem for homeowners who have had perfect credit scores and pride in their payment histories and home ownership.
You’ve come to the fork in the road: you know that you won’t be able to stay in your house, and now you must decide: short sale or foreclosure?
- A short sale involves you working with your lender to sell the property, recognizing that the sales price will be less than the amount left due on the mortgage. Short sales are advantageous to both the lender and the borrower because each side avoids a foreclosure proceeding. However, a short sale alone will not erase the chance of the bank going after the borrower for the amount left on the note in a deficiency judgment.
- In a foreclosure, the lender takes the formal legal steps to take legal ownership of the property because the mortgage is no longer being paid. The bank has a lien on the property and it is through foreclosure that the bank exercises its rights under that lien.
What Happens to Your Credit Rating, or FICO Scores, In a Foreclosure or Short Sale?
In making this decision, you will have a number of concerns – both options have many long-term consequences. However, one of the big issues for homeowners to consider is the impact that short sales and foreclosures have on their consumer credit rating.
Credit scores, or “FICO® scores,” are kept by three national credit reporting companies: Experian, Equifax, and TransUnion. Consumers can access their individual credit reports at no cost by requesting them at AnnualCreditReport.com. The three credit reporting companies maintain this site jointly, and they will not charge for a joint credit report. (Beware of scams that make you pay for what you can get here, for free.)
Your FICO® score[s], as explained by MyFico.com, are used by lenders to assess risk in lending money and how much interest to charge for the loan. The three FICO® scores used by an overwhelming majority of banks and financial institutions in the United States today are those accumulated by Experian, TransUnion, and Equifax.
The name “FICO” for these three credit ratings comes from the software they use to tally each credit score: it was created by Fair Isaac and Company, or “FICo.” Usually, lenders will check all three FICO® scores – from Experian, TransUnion, and Equifax – when considering a loan application.
Short Sale is the Lesser of the Two Evils, Credit-Wise
Make no mistake: both the short sale and the foreclosure will appear on your credit report for the following seven (7) years. Both will have a negative impact on your credit score. However, between the two options a short sale will do less damage to your credit future than a foreclosure.
Here’s why. A foreclosure, by definition, means you stopped paying the debt. The credit reporting agencies will show month after month after month of non-payment. This is very bad for your credit future.
In a short sale, assuming that you’ve kept up your mortgage payments, the only bad thing from the reporting agencies’ perspective is the amount that got left on the table after the house was sold. The amount that the bank must write off, or sue the homeowner to get a deficiency judgment, will show up on the credit reports as “debt settled for less than owed.”
Still bad, but better than a foreclosure. In fact, future lenders may well recognize a short sale as an attempt to work with the lender in a bad financial situation (particularly in today’s economy), and this blemish on a credit report will be a hurdle and and not a barrier to future loans (including mortgages).
Of course, each situation is unique. Credit reporting agencies look at public records as well as payment histories reported to them, and it will be important to your individual credit score to avoid having any Notices of Default, Notices of Foreclosure, or the like placed upon the real estate records for your property. In negotiating with the lender, and in making your decision, the real estate property records — and what impact they have had or could have on your credit rating — will be a consideration.
As myFICO explains, “… [y]our FICO score[s] only looks at information in your credit report. However, lenders look at many things when making a credit decision including your income, how long you have worked at your present job and the kind of credit you are requesting.”
Study on FICO® Scores After Short Sales and Foreclosures: 575-595; 570-590; or 620-640
Of importance here: a recent study released by Housing Wire and discussed in detail on the Banking Analytics Blog last month where Experian, Equifax, and TransUnion data on delinquency in mortgage loans was reviewed with the results showing that (1) if credit scores were similar going in as distressed homeowners, then (2) homeowners with short-sales and foreclosures on their records ended up with similar credit scores.
The study found that both short sales and foreclosures resulted in FICO® scores in the 575-595 range at one bureau, with the other two reporting agencies finding short-sale and foreclosure FICO® scores each resulting in scores in either an 570-590 or 620-640 range.
Before deciding between a short sale and a foreclosure, it’s very important to investigate all your options and all their consequences.
Seek short sale counseling from your lawyer, your banker, know what the real property records reflect, and investigate the marketplace. For example, to get a Florida realtor’s perspective on the two options, read Tampa’s Liane Jamason’s take on the situation. For a credit professional’s perspective, read the article published by Kristy Welsh at CreditInfoCenter-CommunityBlog.