Do a Short Sale or Foreclose? Either Way Your Credit is Shot and It’ll Be Hard To Get a Loan in the Future!

Whether you foreclose, do a short sale or go through a deed in lieu of foreclosure your credit is shot. The extent to which your score falls may differ, but to any future creditor it is all the same. Not only that but when you apply for credit in a few years, its really important to not have any derogatory items on your credit report for at least 24 months prior to an application. For example lets say you do a short sale this month (June 2008) and you apply for a mortgage in June 2011. Then you should not have any derogatory items (late payments) since June 2009. Also, from the recent changes to credit guidelines it may be well after 2011 that you can even apply for a mortgage loan.

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?”

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

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.”

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 ~

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.

Forget Your House, How Much is Your Credit Score Worth?

What is a credit score worth to you? What does it matter whether you have a 720 score or a 695? It’s only 25 points? Well according to MyFICO, a division of Fair Issac, this 25 point difference could cost you almost $31,000 in extra interest payments over the life of the loan. So, in other words, in this situation each point is worth $1,200.

According to a article:

The consumer with a FICO score between 620 and 674 might get a 7.734 percent rate … That’s $55,947 more than the middle-score borrower and $86,949 more than the borrower with excellent credit.

So, what is a credit score worth to you? I know its worth a lot to the lender.

Readers of this blog know I’m not a big fan of using credit improvement agencies. I know certain people can benefit, but for most people it’s not going to be that difficult to reign in on other credit.

Last month, I wrote an article over at Christoph Schweiger’s blog on the Seven Easy Steps To Completly Destory Your Credit . If you do the exact reverse of what I say you’ll be on the right track.

However, for those who want some customized, personal guidance, my wife Aimee has developed a Credit Solutions Program. She will go over your credit report, and by directly talking to the credit agencies she will put together an action plan on which accounts to pay off, which to keep and which to resolve. Then you make a plan to improve your credit, get qualified for a mortgage and find the perfect Realtor so you can buy your dream home.

This isn’t smoke and mirrors folks, Aimee has helped many people with this and last month two of them moved into their first homes because their credit finally made it possible!

I suggest you download the flier, call Aimeeand make a plan to own your home. This is also an attractive solution if you’re in a subprime mortgage and want to make sure your credit is in good shape before your ARM adjusts.

I don’t even want to tell you how much you’ll save if your score is below 619.  You’ll have to go to the article yourself!

What Makes Up the FICO Score?

Below is a pie chart that answers a very common question I receive.

 What Makes Up the FICO Score?

I know the FICO scoring model no longer allows the use of authorized user accounts to boost credit scores. However, there are lots of credit boosting companies out there that promise rapid score improvement at low or minimal cost. I don’t agree with a lot of what they preach so I won’t link to them here. I take a very different approach. For a short term fix I suggest you study the chart carefully and determine methods of improving your score or, at least be headed in the right direction. If you have questions, I can help you with them, but I certainly don’t think a credit boosting company has all the answers either!

The true and tried method to improving your credit score over the long term is very simple. The first is to be vigilant for any potential errors on your report. I recommend using a free service such as to review your report and score annually. You are legally entitled to a free report every twelve months. The second method is to pay all bills on time. I know this can be difficult sometimes but you need to make this a priority otherwise regardless of your income, your score will suffer.

This site is for informational purposes only. It is not sponsored or in any way affiliated with the government. If you are in need of a mortgage loan, consult with a licensed mortgage professional. All fair housing and equal housing opportunity laws apply when applying for a mortgage or buying a home. Copyright 2012.