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FICO, Foreclosures, and Short-Sales Oh My!

If you are wondering what sort of pain your neighbor will feel due to their recent short-sale or foreclosure, you came to the right place.  Your credit score is a black box which is more mysterious than nearly any part of your personal finances.  It seems crazy that a person who does not have any debt has a hard time getting a credit card whereas a person who is burdened with debt but has made every payment gets catered to by all financial institutions.  Since foreclosures and short-sales are rampant around the country, it is interesting to contemplate the true impacts of your neighbor’s default on their financial well-being.

The original FICO score comes from a publicly traded corporation called Fair Isaac which was founded by Bill Fair and Earl Isaac in 1956.  The term FICO actually stands for the company’s name, Fair Isaac & Co. Your FICO score can range from 300-850 and is a statistical calculation which is based upon:

  • Payment History (35%)
  • Credit Utilization (30%)
  • Length of History (15%)
  • Types of Credit Used (10%)
  • Recent Credit Checks (10%)

Items on your credit report that are inputs to the FICO software stay for 7 years.  This means that if you have negative credit events, such as late payments, you should expect it to damage your FICO score for the next 7 years.  Bankruptcy is the deathblow to credit scores.  Bankruptcy helps individuals wipe out their credit burdens entirely, but lingers on your credit report for up to 10 years.  Depending upon how long you wait to file for bankruptcy your score can plummet between 100 & 300 points.  This would significantly increase interest rates on any credit facilities that you are able to access.

Liz Weston claims that she was given an accurate picture of credit damage points from negative credit events directly from Fair Isaac when she asked for the information:

Home foreclosures occur when a borrower fails to make payments on the mortgage and the bank takes possession of the property.  The bank will then liquidate the property and take a severe loss, usually losing upwards of 50% of the loan balance.  Foreclosures are the second most damaging credit score event, with an approximate charge of 85-160 points.

The increasingly popular route of getting out of a distressed property is through a short-sale.  Short-sales can be thought of as negotiations between troubled or simply underwater borrowers and their lending banks.  Banks prefer to negotiate a short sale with the borrower because the losses are often substantially less than with a foreclosure.  The question is whether a short sale hurts your credit score as much as a foreclosure.  The key is in whether you stay current on your payments and how the lender reports the sale on your credit report.  Many believe that the credit damage is more likely in the range of 75-125 because it is listed as a “pre-foreclosure in redemption”.  Even better, borrowers can often negotiate with their lenders on how the sale is reported on the credit report so that it is listed as “debt repaid in full”.

Either way, if you find yourself with a damaged credit report, do not hide behind cash.  The best way to get your credit repaired is to use a credit card and make timely payments.  You can also piggyback on a friend or family member’s credit history by being added as an authorized user.  The friend will not be affected by your damaged credit and you will get a jump start.  Expect up to 100 points to be added back a year for diligent credit use.

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