Short Sales, Foreclosures, and FICO

 Bankruptcy, Consumer Law, Foreclosure, Indiana  Comments Off on Short Sales, Foreclosures, and FICO
Apr 272011

One of the various alternatives available to clients facing foreclosure is a “short sale.”  For those who either do not qualify for a loan modification, or who do not want to remain in the home (for whatever reason), a short sale can allow a homeowner to sell the property (albeit for less than the amount owed) instead of losing the home through foreclosure. 

Of course, most people also want to know what effect each of these alternatives would have on their credit scores.  Other than my typical response that they have more important things to worry about than a credit score – like how they are going to keep a roof over their heads and have enough money left over to put food on the table – I could only guess at what the Magic FICO Ball would have in store.

Recently, however, FICO did some research on how mortgage delinquencies affect credit scores.  What they found was that – well – it depends.  To determine the effects, FICO created three “representative” consumers, each with an active, current, “paid as agreed” mortgage.  Here’s what I took away from the charts:

  • Short sales with a deficiency balance are treated almost exactly the same as a foreclosure.  
  • BUT, once you fall behind on your mortgage payments, and you get a short sale without a deficiency balance, then then you’re not going to be penalized much more (if at all), and certainly not as much as a foreclosure. 
  • Using bankruptcy to save your home (or to get rid of a deficiency balance) has the greatest negative impact – for the short term, at least. 
  • If you’re looking to get back to a 780 credit score, it’s going to take a long time, but it is possible. 

In Indiana, lenders are allowed to pursue the (now former) homeowner for any deficiency (e.g., the amount left on the debt after the sale proceeds are deducted).  The only ways to avoid a deficiency are (a) an agreement with the lender, (b) bankruptcy; or (c) paying it.  Since most people in foreclosure don’t have the resources to pay a deficiency, we’re usually looking at the first two options.  A short sale may result in the deficiency being waived, or an opportunity to settle for a lower amount.  However, if there are more global problems (like a lot more debt than just the mortgage), then bankrutpcy may be the best option.  Of course, each of these options should be discussed with a knowledgable attorney before committing to a particular course of action.

One last thought on FICO:  FICO scores are a reflection of your ability to put yourself deeper into debt.  Too much debt is what brings people into my office.  Taking on more debt when you’re already drowning is not going to help.  Getting out of the burdensome debt, once and for all, is the real solution.  A good FICO score will only help if it allows you to refinance or consolidate your current debts so that you can actually pay them off within a reasonable amount of time.  If you can’t do that right now, then your FICO score is irrelevant.  Focus instead on what you need to do to survive and thrive, without relying on more debt.