With generous new guidelines from Fannie Mae and Freddie Mac likely to stimulate large numbers of short sales by underwater homeowners, what impacts can these sellers expect to see on their credit scores?
It’s a crucial question because short sales typically cause FICO scores to plummet, sometimes by 150 points or more. This, in turn, complicates sellers’ credit capabilities for years and makes additional borrowings – whether for auto loans, credit cards or new mortgages – tougher and more expensive.
The issue arises now because Fannie Mae and Freddie Mac – the dominant sources of home loan funds – recently outlined plans to approve short sales for underwater borrowers who are current on their loan payments, provided they face an imminent “hardship.” Though the numbers of participants in the plan won’t be known for months, the two companies combined have approximately 3.7 million underwater mortgages in their portfolios on which borrowers are making their payments on time, according to federal regulators.
Short sales traditionally have been associated with extended periods of delinquency by borrowers. The technique itself – where the lender agrees to accept less than what’s owed and the property is sold – usually has been employed as an alternative to foreclosure.
As a result, FICO credit scores – the major risk predictive tool used in the mortgage industry – have severely penalized borrowers who opt for short sales. VantageScore, the FICO rival created by the three national credit bureaus, also hits short sellers with triple-digit point losses.
Frederic Huynh, FICO’s senior scientist, said statistical reviews of short sellers by the company concluded that they “represent a high degree of risk” to lenders. More than 55 percent of short sellers in a sample of borrowers between 2007-09 went on to later default on other credit accounts after completing the sale transaction. This ranks them in “the same heavyweight (risk) class” as people who’ve been foreclosed upon, filed for bankruptcy, had a tax lien or collection account.
But hold on. Won’t underwater homeowners who qualify for the upcoming short sale program be fundamentally different? Won’t they have solid mortgage payment histories despite being underwater?