The Impact of a Foreclosure or Short Sale on One’s Credit

With today’s real estate market driven by foreclosures and short sales, a common question today is how will a foreclosure, short sale, or loan modification affect one’s credit score?  Below is some helpful information regarding each one of these areas.  To fully understand these comments, it is important to understand that currently there are no codes or mathematical algorithms that distinguish between a foreclosure, deed-in-lieu of foreclosure, or short sale.  Thus, current credit scoring models treat all three of these occurrences the same.  In addition, it is important to understand that every credit report is based on different variables and, thus, how much one’s score will be impacted is impossible to gauge (i.e. someone with a fabulous long-term past credit history will be less affected than someone with a brief negative credit history).

Foreclosure

• Remains on a credit report for 7 years.
• Current Conforming guidelines require a waiting period of at least 5 years since the completion date of the foreclosure as well as a 10% down payment and at least a 680 credit score.  In addition, no 2nd home or investment property purchases are allowed nor cash-out refinances until the foreclosure has dropped off of the credit report.   
• FHA guidelines require a waiting period of 4 years since the completion date of the foreclosure or 3 years if there have been extenuating circumstances.

 Deed-in-lieu of Foreclosure

• Although this is a “voluntary” foreclosure, it is reported the exact same way as a foreclosure on a credit report.
• The Conforming guidelines are the same as for a foreclosure but require only a 4 year waiting period rather than 5.

Short Sale

• Can be reported as either a charge-off, a settlement, or a type of foreclosure on the credit report (different creditors do it different ways).   
• Thus, how much a score will be affected depends on who is doing the reporting and how they are choosing to report.   
• Despite some reports to the contrary, there is no set answer to how much a credit score will be affected on a short sale.  It is a type of foreclosure, so it is best for one to expect the same foreclosure guidelines as above to be in effect for a short sale unless the foreclosing bank clarifies otherwise. 

Loan Modification

• Under this arrangement, a lender simply lowers the borrower’s rate and payment.  This solution does not reduce the principal balance nor is the lender forgiving any of the debt.  A loan modification is simply a method to avoid foreclosure and it is not considered as serious as the other methods above.
• On the credit report, a loan modification is reported as a “Partial Payment Plan.”
• Credit scores will decrease with a loan modification but how much will depend on the other factors showing on the credit report.

The bottom line is that clearly one’s credit score will be adversely affected by any of the above occurrences, however, the exact amount of impact remains quite a mystery.