People regularly ask me if short sales and foreclosures impact FICO scores differently and how each is evaluated. While I always maintain that each case is unique, new research helps answer some questions.
Let’s start by taking a closer look at short sales. In terms of credit risk, such a settlement is considered a loan default. FICO’s scoring model assesses a derogatory loan on a credit report, focusing on three dimensions: recency of nonpayment, severity (how long overdue is the payment) and frequency (how many accounts have been reported delinquent). A loan default is the most severe type of delinquency, no matter whether it takes the form of a short sale, foreclosure or deed-in-lieu.
Recently FICO published an online study that simulated various types of mortgage delinquencies on three credit bureau profiles of consumers with FICO scores of 680, 720 and 780. Characteristics evaluated were utilization, delinquency history and age of file. All had active currently-paid-as-agreed mortgages at the start of the research.
The key findings found that: (a) the magnitude of FICO score impact is highly dependent on the starting score; (b) there’s not a significant difference in score impact between short sale/deed-in-lieu/settlement and foreclosure; (c) it could take 7 to 10 years to fully recover a score, assuming all other obligations are paid as agreed and there are no new account openings; (d) the higher the starting FICO score, the longer it takes the score to fully recover; (e) even if there’s minimal difference in initial score impact between moderate and severe delinquencies, there may be significant difference in the time required for the score to fully recover.
Servicers implementing home-retention strategies are aided by having accurate credit information to allow them to effectively communicate information and educate borrowers. For lenders and investors, this insight into how the FICO scoring model assesses a derogatory loan and time to recover can be incorporated into their own credit granting and investment policy guidelines to make better decisions.
