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On October 23rd an article called “Damage to credit scores could trip up new Fannie, Freddie short sale program” was published by Inman News. The reporter, Ken Harney, is one of more prolific writers on the topic of housing. I normally agree with Harney’s opinions on housing but every once in a while he veers off course into the world of credit scoring, where the bill of his consumer advocacy hat can sometimes obscure his vision. This article is an example.
The issue is at hand is a new short sale program by both Fannie Mae and Freddie Mac that goes live on November 1, 2012 and will allow mortgage servicers to consider and accept short sale applications from borrowers who are not delinquent on their mortgage loans. In the past short sales were only an option for consumers who were behind on their payments.
This is great. A short sale is now a viable option even for consumers who have worked hard and have never missed a payment. They should be rewarded and being given the opportunity to short sale is a great reward. The option, however, is still only reserved for people with hardships.
Harney rightfully points out that a short sale is currently reported to the credit reporting agencies as a derogatory incident. And, the term “Short Sale” cannot appear on credit reports at this time because there is no such language option for lenders and servicers to choose. They are instead reported as settlements, which means the lender took less than they were owed and considered the debt to be satisfied. Don’t misunderstand that sentence. It doesn’t mean the loan has a $0 balance or has been paid in full. It simply means the lender is satisfied with the amount they have been paid and have agreed to forgo any remaining balance. It’s arguably semantics, I know…but it’s hardly paid in full.
Harney suggests that this credit reporting is a “scoring problem” and could “trip up” the new short sale program. We seem to be forgetting that when a lender loses money on a loan, that’s bad. And, the borrowers who cause lenders to lose money are high risk. Suggesting that we should cut consumers a break simply because they paid their bill on time leading into the short sale ignores the core on which risk management is built…predictive analytics. Short sales are, in fact, indicative of future elevated credit risk. That’s not in dispute and is also not conjecture. To suggest that simply because someone was paid on time before their short sale that they are a good credit risk IS conjecture.
Still it seems like officials at FHFA are looking at ways to fix this problem, which isn’t really a problem but more so an unfortunate situation for homeowners who are upside down. Further, if a government agency chooses to arbitrarily mandate the misreporting of short sales as not being a settlement and “paid as agreed” then future lenders will lose an important piece of information that they definitely want and need in order to properly assess the risk of an applicant.
According to Harney, “Why not instruct lenders and servicers involved with the new short-sale program to report transactions involving nondelinquent borrowers as “paid as agreed”? After all, isn’t that a fact?” The answer to your question, sir, is no, it is not a fact. It is a fact that the loan was paid as agreed before the short sale but to call it paid as agreed after it has been settled is, well, a gross misrepresentation of the actual disposition of the loan. The proper way to report this scenario is to show a clean payment history leading up to the short sale and then a settlement as of the date of the short sale.
Put yourself in the shoes of a lender. If you let someone borrow 250,000 of your dollars and you only got back 185,000 of them…would you consider that loan to be paid as agreed? If so I’d suggest that lending isn’t a good career choice for you.
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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.