If You Do a Short Sale Do You Become and Increased Credit Risk?

A short sale is when you sell your home for less than the amount of the mortgage. This results in a settlement for less than the full amount of the mortgage.  The sale is reported on the credit report as partial payment, settlement or charge off.

The FICO score treats short sales, deed in lieu and foreclosure the same.  Some believe that short sales should not be considered as severe as the other two, because the homeowner is willing to work with the bank; short sales cost the bank less; and the loss was due to the economic times only.

FICO conducted research using data from October 2009 to October 2011 to determine the risk of short sales and other events.   They looked at the credit report of consumers who already had a “stress event” (foreclosure, short sale, or deed in lieu) on their credit report and became 90 days late or more on another credit account within two years.

Chances of going delinquent on another account

The following lists the percentage of people who had a mortgage stress event between October 2009 and October 2011 on their credit report and also defaulted on another account within two years.  This percentage would be translated to a “bad rate”, the chance of going 90 days late or worse on an account in the next 24 months.

86 percent of those with a “partial payment agreement” defaulted on another account within two years.

72 percent of those with a” foreclosure” defaulted on another account within two years.

78 percent of those with a “foreclosure started” defaulted on another account within two years.

61 percent of those with a “paid after foreclosure started” defaulted on another account within two years.

55 percent of those with a “short sale” defaulted on another account within two years.

53 percent of the “derogatory population” defaulted on another account within two years. Derogatory is defined as late 90 days or worse on an account; this includes collections, derogatory public records such as tax liens and bankruptcies.

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50 percent of those with a “deed in lieu” defaulted on another account within two years.

26 percent of the “clean population” (no late payments) defaulted on another account within two years.

Looking at short sales on this list, 55 percent of those with a “short sale” defaulted on another account within two years. In other words, a consumer with a short sale on their credit report has a bad rate of 55%, or a 55% chance of becoming delinquent on an account within the next two years. Compare this to a bad rate of 26% for the population that is considered “clean” or with no late payments, and 53% for the derogatory population.

Even though the bad rate for those with a short sale was lower than for those with a foreclosure, FICO considered all three mortgage events (short sale, foreclosure and deed in lieu) in the same category of exceptional riskiness. Short sales would not be given positive treatment in the score, it still was very close to the delinquent category of 90 days or worse, which is not considered positive. Those with a short sale still had over a 50 percent change of going delinquent on another account – this is one out of every two borrowers. In FICO’s research, those with a short sale also had other evidence of mortgage delinquency. To contrast, those with a score in the high 700s will default 2 percent of the time or one out of every fifty borrowers.

Chances of defaulting on a bankcard

To further compare this information, FICO looked at the bad rate of having the mortgage stress event and defaulting on a bankcard within 24 months later.  The rate was lower than for defaulting on any account, but the rates weren’t low.

49 percent with a “partial payment agreement” defaulted on a bankcard within two years.

49 percent with a “foreclosure started” defaulted on a bankcard within two years.

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44 percent with a “foreclosure” defaulted on a bankcard within two years.

36 percent who “paid after foreclosure started” defaulted on a bankcard within two years.

33 percent of the derogatory population defaulted on a bankcard within two years.

31 percent with a “short sale” defaulted on a bankcard within two years.

27 percent with a “deed in lieu” defaulted on a bankcard within two years.

13 percent of the “total population” defaulted on a bankcard within two years.

3 percent of the “clean population” defaulted on a bankcard within two years.

Again, short sales’ rates (31 percent) were near the derogatory population’s rate (33 percent).  Compare this with the 13 percent bad rate for the total population, and only 3% for the clean population.  There is a one out of three chance of those with a short sale going delinquent on a bankcard and a one out of two chance of going delinquent on any account. These are still high chances.

Credit Reporting Expert, John Ulzheimer, is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a Contributor for the National Foundation for Credit Counseling.  He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry.  Follow him on Twitter here.