Borrowers Need to Understand Three Credit-Score Realities
As a mortgage professional, I work with credit reports and credit scores most of my day. They are the lifeline upon which crucial decisions are made in lending. With the climate ever-changing in the housing market, it is important for me to understand how loan modifications, short sales and foreclosures may affect a borrower’s credit. Many distressed clients are turning to me for credit advice – so the more I know, the better I can help.
This is why I’d like to share information that I feel is important for the masses to understand.
Knowing that credit rules the roost is only the beginning. Client need to improve their overall understanding of their own credit, and I typically like to help them by explaining what’s on a credit report and sometimes offering advice about improving credit scores. Credit not only affects how much money mortgage borrowers must put down, but it also affects the rate they will receive.
When former clients are having trouble making their mortgage payment, the second person they often call after their service provider is me…the person who obtained their financing. I often answer questions such as:
- What options do I have?
- What effect will this situation have on my credit score?
- How long until I can get a new mortgage?
Those questions can sometimes be intimidating, but knowing and understanding the answers does arm me with valuable information and adds an important tool to my professional repertoire. I’m not a credit EXPERT, but I did play one on TV…
The three most-likely outcomes for distressed borrowers are
- Loan modifications;
- Short sales; or
- Foreclosures.
All three of the above have a negative impact on borrower’s credit scores. The size of that impact, however, can vary substantially.
Modifications
Most struggling homeowners first will attempt to modify their loan with their current service provider. Loan modifications have been pushed by the federal government through its Making Home Affordable programs, which include the Home Affordable Modification Program (HAMP).
Servicers with loans that Fannie Mae or Freddie Mac own or guarantee must participate in HAMP, and other servicers have been encouraged to follow suit. In addition, proprietary loan-modification products have been introduced to the market.
In theory, decreasing struggling borrowers’ mortgage payments to a manageable amount is great. All borrowers must do is fill out some paperwork and have their payments drop.
There’s at least one problem, however: Many lenders won’t consider modifying borrowers’ loans unless they’re at least 90 days behind on their mortgage (although they don’t ever come right out and say that!). HAMP rules, however, state that mortgage delinquency isn’t a prerequisite to loan modification.
When borrowers miss a mortgage payment for the first time, their credit scores begin to drop. If they continue to miss payments until a modification is complete, their scores continue to fall.
The road to credit-score recovery begins when the modification is complete. Although borrower’s scores may have taken a significant hit during the modification process, their rebound will occur faster than if they had decided to go through with a foreclosure.
Short Sales
When modification attempts don’t work, distressed homeowners will likely seek counsel to sell the house in question. Often, this is when reality has set in that the house is worth much less than the amount owed. In such cases, a short sale may be required.
Short sales typically harm credit scores more than loan modifications but less than foreclosures. A line that appears in the credit report like, “Settled for less than full amount,” likely will be inserted after the short sale. Such a report can subtract 100 points from credit scores.
Homeowners facing short sales also will have seen previous knocks to their credit scores if they were late making any mortgage payments. For those who stayed on top of their payments despite needing to execute a short sale, a 100-point drop could seem fair. Short sales can linger on credit reports for as many as seven years.
Foreclosures
When modification and short sale attempts fail, borrowers typically have one final option: foreclosure. Borrowers who undergo foreclosure will see their credit scores plummet, after the scores are first tarnished by the nonpayment of the mortgage. In most foreclosure scenarios, credit scores continue to decline until the process ends, which could be as long as one to two years.
After the foreclosure hits the report, scores can drop by as much as 200 points. Foreclosures will stay on credit reports for seven years.
According to a recent FICO report, credit scores can dip by as many as 160 points following a foreclosure – not counting late payments (see the Credit-Score Effects sidebar below).
Credit counseling has always been part of my duty as a mortgage professional and I expect that to continue forever. Informing my clients and any distressed homeowners about their options right now in this marketplace is a key to the longevity of their financial profiles. I personally believe homeowners have a right to expect that from the person and/or company who originated their mortgage in the first place.
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