If selling short, expect a hit
WASHINGTON — 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 tougher and more expensive.
The issue arises now because Fannie Mae and Freddie Mac 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 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.
In a blog post, Frederic Huynh, FICO's senior scientist, said 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 default on other credit accounts after completing the sale transaction. This ranks them in "the same heavyweight (risk) class" as people who have been foreclosed upon, filed for bankruptcy, had a tax lien or collection account.
But 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? Why should they have to take the same heavy hits to their scores as people who didn't pay their mortgage for months on end?
It appears that these sellers won't get the break they deserve. The current scoring system, credit experts say, isn't set up to recognize — or properly report — short sales by on-time mortgage customers to the national credit bureaus. And the credit score companies aren't planning to make any changes to the penalties their models assign to people who participate in short sales.
Anthony Sprauve, a spokesman for Fair Isaac Corp., developer of the FICO score, says that "in general," when a "loan (is) paid off for less than the full balance," it is "classified as a severe negative item" by the FICO scoring model. And "there are currently no plans to change."
Sarah Davies, senior vice president for research and analytics for VantageScore Solutions LLC, said her company won't likely modify its scoring algorithms either, even though the seller was not delinquent and came to a mutually satisfactory resolution with the lender.
Terry Clemans, executive director of the National Credit Reporting Association, an industry trade group, says this is all "unfair" for borrowers who have continued to make timely payments on their loans. Crushing them with deep credit score penalties "doesn't reflect the fact that these people are actually excellent credit risks. They simply encountered an extraordinary situation" — the national home value bust — which put them underwater.