From the mailbag:
If I owe $175K on a VA mortgage on my primary residence and the bank agrees to “forgive” $25K because the best I can sell my house for is $150K will this negatively affect my cerdit rating?
Most likely this will adversely affect your credit. The extent will depend on how the bank reports the “cancellation”. They could report it as a foreclosure, short sale, deed in lieu of foreclosure or anything in between. If it is a foreclosure then of course that would be the worst case scenario in terms of credit score. Even though a short sale and deed in lieu of foreclosure may not affect your score as adversely as a foreclosure it really shouldn’t be too big of a difference. Even though I can’t say by how much your score will fall, don’t be surprised by what you see.
Even though the reporting may vary, in the future, when you go to apply for a mortgage, the lender will most likely view all three as a foreclosure. An instance where you were not able to meet the mortgage payment and hence had to be releived of the obligation through legal action. Regardless of what your credit score is at that point or whether it says foreclosure or not, the new lender will treat it as such.
This isn’t a dire situation though. Lenders will still give you a loan but only after a minimum of three years after foreclosure. In fact you can get a 100% loan today three years after foreclosure, as long as you have maintained good credit since that time. I can’t say whether these loan guidelines will not change in the future.
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on May 27th, 2008 at 1:04 pm
You’re very mistaken as to the impact of foreclosure vs. short sale vs. deed-in-lieu.
As a mortgage broker myself, I get many calls these days from consumers wondering what affect a short sale or foreclosure (or deed-in-lieu of foreclosure) will have on their credit. This is an important topic because the last real estate downturn (during the 1990s) preceded the widespread use of FICO scoring and automated underwriting systems.
Some real estate agents and short sale investors (those seeking to purchase a homeowner’s property prior to foreclosure)–and even some mortgage professionals–suggest to the distressed homeowner that a short sale isn’t as damaging to one’s credit as a foreclosure. Given the inherent conflict of interest—a real estate agent makes a commission on a short sale and doesn’t in a foreclosure—the real estate professional should proceed cautiously when counseling a seller. The practical reality is, short sale or foreclosure, one’s credit will suck either way.
Many mistakenly believe that a derogatory public record such as foreclosure is somehow worse than petitioning the lender to accept less than owed (short sale). In the world of banking, however, lenders interpret either of these events only one way: the customer did not pay as agreed. It matters not to a lender the manner by which it suffered a loss; only that it did. Lenders go to great lengths to alert each other, by way of reporting to credit bureaus, that the defaulting homeowner is someone who, when the chips were down, didn’t honor a contract.
In fact, lately Fannie Mae and Freddie Mac took an even stronger stand against homeowners who renege on their obligation. “Seasoning” of a foreclosure or short sale is now five years.
Fannie Mae Tightens Guidelines Again
http://calculatedrisk.blogspot.com/2008/04/fannie-mae-tightens-guidelines-again.html
In the world of FICO scoring, there are three credit events that will severely sink a FICO score, and they all carry exactly the same weight. They are (1) serious delinquency, (2) derogatory public record or (3) collection filed. A homeowner in default is technically “in collection.” These events are reported to all three bureaus as “Score Factor Code #22.”
http://www.bayhouse.com/FairIsaac-NextGen-risk-factors.shtml
A foreclosure will remain on a consumer’s credit report in the “public records” section for ten years. In addition, this fact must be attested to on the loan application under “Declarations,” Section VIII, as follows:
(c) Have you had property foreclosed upon or given title or deed in lieu thereof in the last 7 years? (Y/N)
(e) Have you directly or indirectly been obligated on any loan which resulted in foreclosure, transfer of title in lieu of foreclosure, or judgment? (Y/N)
Because the term “short sale” is not expressly stated, some interpret this as meaning that a short sale is a lesser offense. The truth is, decision makers in the lending industry know that a short sale is no different than a foreclosure or deed-in-lieu. Here are two excerpts from a lender’s underwriting guidelines.
The following items are subject to individual evaluation, no matter how high the
credit score:
• Bankruptcy, foreclosure, deed-in-lieu, short sale.
• Judgments, collections, charge-offs, tax liens.
~ and ~
Foreclosure
None in past 4 years with minimum 3 active trade lines more than 24 months old, with no late payments or derogatory credit after the foreclosure.
Definition of Foreclosure: Any 120 day mortgage late within the last 24 months, any notice of default or settlement on a real estate secured trade line (short sale), any deed-in-lieu or forbearance agreements.
To the homeowner with a mortgage he can no longer afford, the decision to voluntarily vacate through a short sale or be forced out by foreclosure can be agonizing. The sterling credit reputation it may have taken a lifetime to establish is gone with a single event. Most landlords with whom I’ve spoken state that, due to the widespread credit meltdown, they would view a foreclosure as not particularly onerous—provided that all other credit obligations were met on time. A credit report riddled with “derogs” over a broad category of obligations would be viewed negatively.
For the homeowner who, if he remains in default, must eventually vacate his home, there may be an emotional advantage to avoiding the social stigma of the “F” word—foreclosure. He can tell himself and his friends, “I’ve never had a foreclosure,” but to his lender and the credit bureaus, foreclosure and short sale are exactly the same.
This article is intended not as a judgment of the motive or character of a homeowner in distress, but to present the facts so that no one is misguided. There’s no credit preservation advantage to short sale over foreclosure. The nation’s two largest mortgage investors, Fannie Mae and Freddie Mac—with certain exceptions—won’t lend again for five years. A consumer’s FICO score will take a huge hit either way until responsible credit behavior supplants the major hit of foreclosure/short sale over a period of time.
on Jun 2nd, 2008 at 7:12 am
[...] I had discussed this point in response to a visitor question back in December 2007. Recently another reader, who happens to be a very knowledge mortgage broker, left me a comment clarifying the current guidelines and how things are viewed today. I figured it would be to everyones interest to have the comments published as a post. So, below is the response from Catherine Coy to my post from last December “Will “Forgiven” Debt Affect My Credit Score?” [...]