One of the key issues we always examine with consulting with upside-down sellers is the impact of a short sale or a foreclosure on their credit.  While not as damaging as the risk of a deficiency judgment or debt forgiveness tax, credit damage impacts both the capacity to get another loan and can often adversely impact a borrower’s job and career.  To get  greater clarity on the credit impacts, I contacted Jeff Sipes at Blue Water Credit (www.bluewatercredit.com) which helps people restore their credit standing.  Here’s what Jeff provided:

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By Jeff Sipes, Blue Water Credit:  I am often asked what the impact of a short sale or foreclosure is on a credit score.  Unfortunately, there is no straight-forward answer. This is such a difficult question to answer simply because it depends on a variety of factors. In general, a short sale or foreclosure will affect your credit score 85-160 points. Many mistakenly believe, or are misinformed, that a derogatory credit event such as a foreclosure is somehow worse than a short sale. In the world of credit scores, however, both of these events look the same way; the customer did not pay as agreed.

What Is A Credit Score?

A credit score is the statistical prediction of one’s likelihood to pay late over the next two years.  The higher the score, the less likely one is to have a late payment.  The bank then uses this number to assess the amount of risk involved with lending someone money.  Banks are a lot like a casino in a sense, they like to place bets where they feel they will win.

Be aware that there are multiple credit scoring models.  Some of the credit scores in these models go up to 990.  While there are multiple formulas for calculating credit scores, the formulas introduced by the Fair Isaac Corporation (FICO) are the most widely used.  This score ranges from 300-850. Fair Isaac recently released a report stating that credit scores are affected nearly the same whether you go through a foreclosure or short sale. The report stated that the average points lost on a FICO score are as follows:

• 30 Days Late = 40 to 110 Points
• 90 Days Late = 70 to 135 Points
• Foreclosure = 85-160 Points
• Short Sale = 85-160 Points
• Deed-in-lieu = 85-160 Points
• Bankruptcy =130 to 230 Points

How Are Short Sales Reported To The Credit Bureaus?

FICO does not differentiate between a foreclosure and a short sale. Further complicating matters, lenders don’t have a uniform standard as to how they report a short sale to the credit bureaus. Some lenders report short sales as “settled as agreed” while others may report it as “account legally paid in full for less than the full balance.” In some cases, if the account is more than 120 days past due, the short sale will automatically show up as a “foreclosure” on the credit report.  Both a short sale and a foreclosure will report on your credit for seven years from the date of first delinquency.

How to Maximize Your Credit Score during a Short Sale or Foreclosure

Since the number of delinquent accounts is factored into the score, try not to let any other accounts become late or delinquent (if possible).  The second largest factor of your credit score is your debt ratio (the limit of your credit cards compared to the balances you carry) try not to let your balances exceed 30% of the limit.  Only apply for credit when absolutely necessary.  Do not close your credit cards.  If you are able to do all of these things you will be back into the 700’s before you know it.

Credit scores play a large factor in our lives, but ultimately we have many other priorities that are more important.  Credit, like many other things, will be healed over time.

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The information presented in this Article is not to be taken as legal advice. Every person’s situation is different.  If you have specific questions about dealing with upside down loans or real estate, be sure to contact a real estate attorney in your State.  We provide advice worldwide concerning California property. Please feel free to contact us at sjbeede@bpelaw.com. We offer a $200 flat fee attorney consultation to review your situation and help you evaluate and choose the best opportunities. This can be done in person or by phone. If interested, please call us at 916-966-2260.

Over the past several years, we’ve assisted thousands of property owners in coping with upside down loans. Although very few have gotten actual modifications that made their homes affordable (the lenders and our government won’t go that far), most have used short sales to avoid judgments against their credit that would follow them for years.  Even most people who have gone through foreclosure have avoided the lenders’ deficiency recourse.  But now, many are shocked to discover that, although the lender has no judgment against them, the debt still appears on their credit reports as an unpaid debt. This can block future credit and could possibly used by a collection agency to force a payment that is no longer owed.

When a property is sold in a short sale, agreements are generally made with the lenders in which the unpaid balance is forgiven, ie: there is no deficiency recourse.  Similarly, in California at least, most foreclosures are done through a Trustee Sale process through which the foreclosing lender has no recourse against the debtor for any unpaid balance.  These unpaid amounts are considered “forgiven debt” and the debtor may be taxed on this amount unless they have an exemption such as the 2007 Federal Debt Forgiveness Relief Act, or their accountant determines that they are otherwise exempt: purchase money debt, insolvency, etc.  When this occurs, the debtor’s credit report should show the loan as “settled”; or “paid less than full” or some similar reference… not that anything further is due.  So what do you do if this happens.

First, get your records together to show that the loan deficiency was actually resolved.  This may be the short sale closing documents, particularly the lenders’ short sale consent letters addressing the deficiency (or removing any deficiency language). For a foreclosure, the type of foreclosure used will provide guidenance. In either case, the debtor should receive a 1099 form from each lender. A 1099C indicates that the debt is forgiven but sometimes the lenders use the wrong one.

Second, send a dispute letter to each of the credit bureaus - Experian, TransUnion, and Equifax - and challenge the debt reference. Send this my Certified Mail Return Receipt and keep all your records.  Once the credit reporting agency has received your dispute letter, they are obligated to investigate. According to the Fair Credit Reporting Act, the credit bureaus must take the following steps:

• The credit reporting agencies must resolve consumers’ disputes within 30 days limit, unless you have used the services of annualcreditreport.com, then the bureaus can take up to 45 days.
• In response to consumers’ complaints that documentation in support of their disputes was disregarded, the credit bureaus have to consider and transmit to the furnisher all relevant evidence submitted by the consumer the first time.
• Consumers will receive written notice of the results of the investigation within five days of its completion, including a copy of the amended credit file if it changed based on the dispute.
• Once information is deleted from a credit file, the credit bureaus can not reinsert it unless the entity supplying the information certifies that the item is complete and accurate and the credit bureau notifies the consumer within five days.

All of the big-three agencies are working on making sure that all disputes are handled within 30 days. See http://www.creditinfocenter.com/repair/Repair.shtml#4 for more specific details.

If a lender fails to respond to the credit bureau’s investigation, they may delete the refeence themselves. If not, or if the lender actually refuses to remove the derogatory credit reference, then you may need to initiate legal action against the lender. Reporting a false debt on the debt reporting system is slander and you could have a legal claim against the lender and the reporting credit bureau to both remove the reference and recover damages.

Are these strategies for you?  Every person’s situation is different. The information presented in this Article is not to be taken as legal advice.  If you are facing false credit reports which claim you still owe a forgiven debt, get competent legal advise in your State immediately so that you can determine your best options. 

If you have specific questions about your liability in California or about cleaning your credit report, short sales, foreclosure, or any legal issues, feel free to contact us at sjbeede@bpelaw.com.  We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260.