Loan Defaults and Late Pays Have Damaged FICO Scores

Debbie Bremner November 12, 2009

With all the mortgage delinquencies, short sales and foreclosures in the past 3 years at an all time high, there has been a deterioration of average FICO scores across the board, and the number of borrowers with individual credit scores that have dropped dramatically is at at an all time high.

When you do a short sale of a house, or modify the mortgage, is there much of an effect on your credit score? What if you walk away from the mortgage altogether? The simple truth is that the way you handle your mortgage problems, both during and after, can have dramatic effects on your credit scores.

For example, loan modifications that incorporate late payments and penalties into the existing debt owed on the house can actually increase borrowers’ scores modestly. If you take advantage of the Making Home Affordable (MHA) program to refinance your home that has little or no equity due to market value decreases, there may be little or no negative effect on your FICO scores. How you handle a HAMP (Home Affordable Modification Program) modification by following the terms of your agreement has a direct bearing n the success of improving or maintaining your credit score.

When homeowners negotiate a short sale with lenders, they sometimes assume that there will be relatively little effect on their scores. After all, the loan was successfully paid off, there was no foreclosure, and the lender voluntarily agreed to accept a lower balance than was owed.  But in most cases, short sales can trigger big drops in credit scores. Bremner Group Financial and Mortgage team member Steve Eckhoff says that a homeowner with an excellent score of 862 might drop as much as 120 to 130 points after a short sale.  Although it’s true the lender may lose less money through a short sale compared with a foreclosure, it is still a negative credit event, and as such is reflected in your overall FICO score. The full debt was not repaid and the lender lost money.

Here in California, some borrowers have taken the path of the “strategic default”, walking away from their mortgage debts altogether. How will this affect FICO scores? They should expect 140- to 150-point drops to their scores, plus negative marks on their credit bureau files for as long as seven years.  People who file for bankruptcy protection covering all their debts (mortgage, credit cards, auto loans, etc.) will get hit with an average 355- to 365-point drop in their scores. Bankruptcies remain on borrowers’ credit bureau files for 10 years.

Soo if you are a homeowner facing financial hardship, how can you experience minimal dings to their credit, and how can you get your score back up quickly?

First, contact your loan servicer or lender early, when you first discover that you may have trouble making their monthly payments.  Don’t let fear, embarrassment or lack of information stop you from taking the first steps toward a loan modification or refinancing.  Your Realtor® can help you get all the necessary documents together, and walk you through the process.  We are here to help.

Start that conversation early. If you wait and fall several payments behind before seeking a modification, you can lose 240 points on your score and damage your ability to obtain credit for years. Call your Realtor® the moment you believe a problem might be on the horizon.  I help my clients by confidentially explaining all of their options, and help them move quickly to take all necessary and relevant steps to cope with the situation.  If you don’t have a Realtor®, we’d be happy to assist you in finding a knowledgable and trustworthy expert in your area.

If you’ve lost your home to foreclosure or in a short sale, you may be able to buy another place in as little as two years if you take steps immediately to rebuild your credit. Watch for our next post to tell you about what steps you should take right now to start improving your FICO scores.

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  1. You say if you walk away you will take 140-150 point hit, but then you say if you stop paying you will take a 240 point hit. The 240 point hit seems accurate as that is the hit I have taken so far and haven’t paid in 11 months. Are you saying when the foreclosure completes there will be an additional 150 point hit?

  2. Hi DG;
    First of all, let me say that I am sorry that you are suffering this financial hardship. Remember that each lender, and each situation is unique. It really depends on how you handle the communication with your lender. If you are candid with them about your situation, and tell them about your hardship as soon as it happens, they will work with you under a HAMP or MHA modification. This will be a neutral or possibly beneficial event, depending on how you respond to the terms of the new agreement. This is most favorable for you long term with respect to your FICO score. If you cannot keep your home, a short sale negotiated without late payments has the least affect on your credit score. If you are late on payments for extended periods of time, your score will suffer with each negative reporting of delinquency. If you default altogether, the so called “strategic default”, the lender looks upon that much less favorably. And those black marks remain with the credit bureau reporting for years.
    I cannot stress enough that it is crucial to maintain a constant dialog with the lender. They do not want to foreclose; it is in their best interest financially to modify of short sell.
    Thanks and best of luck!