FICO: Quantifying the Damage, How Short Sales May Impact Credit Scores

by Alex Stenback on December 3, 2009

credit-score-damage-points.jpgFICO, purveyer of the widely used credit scoring model of the same name, has always held information on how their models score specific behaviors – like bankruptcy - a secret.  In fact, it wasn’t long ago that the score itself was supposed to be kept from the consumer.

This is all changing, and FICO is now giving consumers a peek under it’s skirts by revealing how many points a consumer can expect their credit score to drop for credit-related transgressions.

Jeremy Simon from Yahoo Finance explains (see also chart at right):

“The “damage points” data, unveiled recently by FICO, are part of the most revealing glimpse into the firm’s once-secret — and still mysterious — credit scoring model. The new information discloses how many points borrowers’ scores will drop when they make the most-common mistakes.”

Also, since our post the other day regarding short sales and credit (quickly: A common misconception, reinforced by the media, is that a short sale can help one “preserve” their credit rating.) I’ve done some digging, and here’s the scoop:

There is no credit reporting designation of “short sale.”  It seems that servicers have mostly been reporting them as “settled” or “charged off,” either of which have a serious derogatory impact on FICO scores – basically, the negative impact of a short sale is on par with a foreclosure, repossession, charge off, and other types of bad debt. 

So referring to the chart above, a short sale will likely result in a drop of 45 to 65 points for a sub-700 score, and a 105 to 125 point drop for scores in the upper 700’s. 

Note that the key here (at least until the industry decides on how they will report short sales) is how the account is reported.  I’ve heard more than one first hand account of a borrower negotiating (read: paying) how the account will be reported as part of their short sale – and if it’s reported as paid as agreed, and there have been no late payments, the impact on credit score may likely be negligible.

Now, this is in some sense “preserving” your credit rating, but unless you decide to lie to a lender in a future application (this is called fraud, don’t do it) a high credit score won’t get you another home loan any sooner.  It will still take 2-4 years, depending on the circumstances.

{ 2 comments… read them below or add one }

Chuck December 9, 2009 at 5:59 am

Alex – realistically, if someone with an ‘exotic’ loan (Interest-Only, Option ARM) is facing a huge payment increase, say $1400 to $3500 per month, are they going to attempt to preserve Credit Score, or walk-away from a loan that’s far far too big for their income?

( I know a few well-off folks in Lake Harriet area who are in this position )

Alex Stenback December 9, 2009 at 10:43 am

Totally depends on the circumstances. If they truly cannot afford the home, but are still employed and have income, I think many would at least attempt a short sale or a Modification before walking.

Still, many others probably just walk. The walk-aways seem so be in two groups – those who could never and will never be able to afford the property long term, at any reasonable terms (this group includes speculators and stuck flippers as well as buyers who just were not paying proper attention and underestimated their risks) and those that can afford the home, but see how far upside down they are and essentially trade their credit score (and ability to finance real estate for a few years) for $100K.

This is the problem (in many cases walking away is by far the most economically rational course) that has the banks in a terrifying puke-fest over continued declines in real estate values.

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