Home > Credit Score > Why are Short Sales So Bad for Your Credit?

Comments 0 Comments

I recently wrote about the negative impact of short sales and foreclosures on credit scores, and how such a mark on your credit report can knock as much as 160 points off your score.

While intuitively this kind of severe impact isn’t so surprising in the case of a foreclosure, some people are surprised that this same impact can be felt following a short sale or mortgage modification.  Some even argue that FICO scoring is too hard on consumers who “do the right thing” by working with their lender toward a short sale or mortgage modification, versus simply walking away from their obligations (aka strategically defaulting) — especially when you consider that the drop in home values is not their fault.

Harsh treatment or not, and despite the responsible consumer behavior demonstrated in these situations, when talking about the validity of credit scoring in predicting any kind of future risk, the question should always be, “what does the data show?”

When it comes to evaluating some of the credit risk associated with certain “mortgage stress events,” FICO scientist, Frederic Huynh, answered that question this week in his FICO Banking and Analytics Blog post. Huynh reveals the results of some recent FICO research that looked at 2009 to 2011 data to see how consumers handled their other non-mortgage credit obligations following a short sale, foreclosure, deed-in-lieu of foreclosure, mortgage modification, or other such outcome.

What this study shows overwhelmingly is that people who encounter difficulty paying their mortgage — regardless of how the difficulties originated or how they were resolved — are much more likely to “go bad” on another debt within two years after such difficulty than those with clean credit histories.

How much more likely are they to go bad? Compared with those having a clean credit report, a consumer who has sold a home via short sale has:

  • More than a 50 percent chance of defaulting on another account within two years;
  • The same likelihood of going bad on another obligation as someone with a 90-day (or worse) late payment, collection, or derogatory public record (bankruptcy, tax lien, judgment) on her credit report;
  • In most cases, been late on a mortgage payment prior to the completion of the short sale.

Huynh also addressed the issue of mortgage modification by saying it’s too soon to assess the link between this mortgage status and future risk, due to the relatively short time since the mortgage modification credit reporting codes have been in place (since 2010).  Typically, it takes a full two years of data to adequately analyze the risk implications of any of these situations.

Nevertheless, FICO has given us a peek into some of the mortgage modification data they’re researching by way of the “Partial Payment Agreement” statistics also included in this study, as this description is how many of the mortgages undergoing a loan modification are reported at the CRAs (consumer reporting agencies). According to the data so far, a whopping 86 percent of consumers with mortgages in a loan modification reported to the CRAs as being in a “Partial Payment Agreement” appear likely to default on another account within two years.

So, while some of the FICO score treatment toward responsible consumers doing the right things might seem a bit harsh in the case of short sales and mortgage modifications, FICO has presented some strong evidence that, on the contrary, the score is doing its job.

If you are interested in getting a mortgage after a short sale? Read these expert tips.

Image: Ines Hegedus-Garcia, via Flickr

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team