WASHINGTON -- With new guidelines from Fannie Mae and Freddie Mac likely to stimulate large numbers of short sales by underwater homeowners, what credit-score impacts can these sellers expect?
Short sales typically cause FICO scores to plummet, sometimes by 150 points or more. This, in turn, complicates sellers' credit capabilities for years and makes other borrowing -- whether for auto loans, credit cards, or new mortgages -- tougher and more expensive.
The issue arises now because Fannie and Freddie, the dominant sources of home-loan funds, recently outlined plans to approve short sales for underwater borrowers who are current on their loan payments, provided they face an imminent "hardship."
Although the numbers of participants won't be known for months, the two companies combined have in their portfolios approximately 3.7 million underwater mortgages on which borrowers are making their payments on time, according to federal regulators.
Short sales traditionally have been associated with extended periods of delinquency by borrowers. The technique itself, in which the lender agrees to accept less than what's owed and the property is sold, usually has been used as an alternative to foreclosure.
As a result, FICO credit scores -- the major risk-prediction tool used in the mortgage industry -- have severely penalized borrowers who opt for short sales. VantageScore Solutions LLC, the FICO rival created by the three national credit bureaus, also hits short sellers with triple-digit point losses.
In a recent blog post, Frederic Huynh, senior scientist for FICO, which was developed by Fair Isaac Corp., said statistical reviews of short sellers by the company concluded that they "represent a high degree of risk" to lenders. More than 55 percent of short sellers in a sample of borrowers between 2007 and 2009 went on to default on other credit accounts after completing the sale transaction.
But won't underwater homeowners who qualify for the short-sale program have solid mortgage payment histories despite being underwater? Why should they have to take the same heavy hits to their scores as people who didn't pay their mortgage for months on end?
It appears that these sellers won't get the break they deserve. Credit experts say the current scoring system isn't set up to recognize or properly report to the national credit bureaus short sales by on-time mortgage customers. And the credit-score companies aren't planning to make any changes to the penalties their models assign to participants in short sales.
Terry Clemans, executive director of industry trade group National Credit Reporting Association, said this is inherently unfair for borrowers who've continued to make timely payments on their loans.
A Fannie Mae spokesman, Andrew Wilson, said his company has no control over how short sales -- whether of borrowers who paid on time or those who didn't -- are scored.
However, when borrowers do a short sale rather than force the lender to foreclose, they are potentially eligible for a new mortgage within two years after a short sale. People who go to foreclosure, by contrast, may not be able to get a new Fannie loan for up to seven years.