Various mortgage problems have different effects on credit scores
WASHINGTON — Financially stressed homeowners looking to cut their mortgage payments through a loan modification, short sale or principal reduction needn't wreck their credit scores in the process.
In fact, according to a study covering more than 400,000 active credit files, some modification options can actually increase your score rather than depress it. Other alternatives can tank your score and take years to rehabilitate.
The study was conducted by VantageScore Solutions, a joint venture created by the three national credit bureaus: Equifax, Experian and TransUnion. The VantageScore, being used by growing numbers of mortgage lenders and banks, is designed to be an alternative to the FICO score.
The VantageScore scale runs from 501 to 990, with low scores indicating high risk for the lender. FICO scores run from 300 to 850. According to Sarah Davies, VantageScore Solutions' senior vice president for analytics, the two scores show roughly similar impacts of loan modifications, short sales, foreclosures and bankruptcies on consumers with similar credit histories.
People with excellent scores at the time of a loan modification — those who have paid their mortgage and other credit accounts on time — might find their score depressed by 30 to 40 points after a modification that involved deferral of payments for a period of months.
The same consumers could see a small net gain in their scores — about 10 to 30 points on average — if their lender modified their loan by forgiving 10 percent of the balance owed and choosing not to report that forgiveness as a charge-off to the credit bureaus. If the lender reports a charge-off, the score could drop by 100 points or more.
Modifications involving what lenders call "recapitalizations" — rolling delinquent payments and fees into a new balance typically carrying a more affordable interest rate — can also increase scores modestly, the study found. On the other hand, homeowners who do not pursue — or whose lenders do not grant — modifications can end up in short sales, foreclosure or bankruptcy with major hits to their scores.
For homeowners with good credit, a short sale can lower their scores 130 points instantly. A foreclosure for the same homeowner is worse: a 140-point decline. A bankruptcy filing almost certainly means a drop of up to 365 points.
"If someone is on the margin and can find a way to avoid bankruptcy," said Barrett Burns, CEO of VantageScore, not only should he or she pursue it but "ought to know what the consequences are."
VantageScore also examined how quickly homeowners could bounce back from one or more negative events connected with their mortgage.
Imagine borrowers who start with a score just above 600. Restructuring their loan drops their score more than 100 points. Their score can rebound to 700 in just nine months if they make on-time payments on all of their credit accounts.
Borrowers who file for bankruptcy can expect only minimal gains in scores plus a huge negative mark on their credit files for at least seven years.
Other noteworthy findings in the study:
• Credit scores assign disproportionate weight to mortgage payments over other accounts.
• Growing numbers of homeowners appear to be ignoring this by paying credit cards and auto loans while going delinquent on mortgages.
Davies said it's not yet clear whether this is a temporary trend connected with the housing boom and bust or a longer-term shift. But whichever the case, it's the wrong strategy for borrowers who care about their credit scores.
Contact Ken Harney at [email protected]