Why Short Sales Tank Your Credit

short sale credit score tankIt’s rough out there, housing prices are continuing to drop, and that beautiful 3 bedroom you bought in 2006 with an interest only loan is now worth half of what you bought it for.

And even though it’s currently worth a heck of a lot less than what you paid, you’re still on the hook with the lender for the whole amount.  As the rest of the world continues to slide into the abyss, you still struggle every month to meet your obligations. Until the day comes and you either hit the wall, or need to move on to greener pastures.

Being responsible, you weigh your options of what to do with your biggest asset that is currently completely upside-down.  You expert analysis indicates the following options:

  • FORECLOSURE or STRATEGIC DEFAULT
    • Walk-away, and let the bank take back the house through foreclosure and let them deal with the problem.  While this type of “strategic default” seems like an easy option, you know that not only does it just feel wrong, it is going to have long-lasting repercussions on your credit score and your ability to qualify for another mortgage any time soon.
  • RENT THE PROPERTY OUT
    • You can try and rent it out to cover your monthly obligations.  And while this sounds like the perfect solution, deep down you know the truth, you’re never going to be able to cover your nut, and you’re going to be out-of-pocket to cover the gap between the rent you receive and the carrying costs of the house (including property taxes, maintenance, etc.).  Not only that, but you have the dubious joy of becoming the landlord/debt collector/handy-man for you new tenants.  Not to mention the costs of carrying the house while it’s vacant, and the cost of acquiring new tenants.
  • SHORT-SALE OR LOAN MODIFICATION
    • Aha, you think.  Let me get the best of both worlds.  I will work with the bank or lender to make them as whole as possible in the current situation by doing either a short-sale, selling the house at fair market value, or staying in the house and doing a loan modification.  In your mind this is the responsible thing to do, and it makes sense.  You are not simply walking away, as millions have already done, you are working with the lender to mitigate the damage from a situation that is global in nature and outside of your control.

This, a short-sale or loan modification, is the perfect compromise, or so you think.  You get relief from paying a mortgage on a house that is worth less than you bought it for and the bank doesn’t have to go through the expense of the foreclosure process and caring for the property until they figure out what to do with it.

This you think, is not only the most fair option, it is the responsible thing to do.  And in reality, you’re right.  It is the best of both worlds, the banks end up in a better position, you end up in a better position.

SO WHY DOES DOING THE BEST, MOST RESPONSIBLE THING DROP YOUR FICO SCORE BY 160 POINTS OR MORE? 

Yes, you heard that right.  Doing the best thing, the most responsible thing for all parties involved will cause your FICO score to tank, and tank fast.  In many cases by 160 points or more.

FICO analyst Frederic Huynh recently defended this huge credit score hit in a blog post on the FICO site.  In it he reveals that FICO has researched data from 2009-2011 from consumers who have done the responsible thing and participated in a short-sale, loan modification, deed-in-lieu and other mitigation solutions, and how those consumers have handled their non-mortgage related obligations after the event.

The data shows that even though the consumer may have acted responsibly in this transaction, that going forward there is a high propensity of further financial distress for the consumer including:

  • The responsible consumer has a greater than 50 percent chance of defaulting on a non-mortgage related account within two years of the event;
  • The responsible consumer has the same likelihood of default on other obligations as someone who has a 90 day late, collection, bankruptcy, tax-lien, or judgment on their credit report; and
  • The responsible consumer, prior to the short-sale had been late at least once on their mortgage payment

As the FICO score tries to predict consumers action in the future, their reasonings for killing your credit score, even when doing the right thing, becomes a little more clear.

Is it fair? That’s a discussion that is certainly worth having, and I believe we should.  Weigh in with your opinion in the comments below.

And, if your credit has been affected by a short-sale, or tanked for some other reason be sure to register for our Free Credit Secrets Video course to see how you can mitigate the damage to your credit report and score.

Image: FreeDigitalPhotos.net

About Anthony Candella

Anthony is the founder and Directing Attorney of YourCreditAttorney.com and has been helping consumers just like you understand and improve your credit and financial situation since 2003.