This is a really interesting article by Yves Smith of Naked Capitalism on"FICO's Dubious Explanation of Why It Treats Short Sales the Same As Foreclosure".
The article quotes at length FICO's explanation of the future probability of a negative credit event within two years of the default, and how short sales have a 55% rate of a second default. It also points out flaws in the FICO logic. When comparing short sale to foreclosure, there is more to the story than just credit score, however.
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There are so many variables and without a minimum 10-year cycle of historical precedent, these studies are largely pre-mature.
Short Sales closed in 2009 through 2018 with the FICO algorithm report produced in 2019 are going to be most accurate. They must use the start date from when there was institutional change to credit reporting systems mandated by Congress. Even better would be to start one year later as banks and lenders were very slow to make those adjustments.
The GSE, lender, default insurance provider, and Wall Street securitizer caused homeowner equity implosion does not show up in these calculations. That extraordinary baked in factor, which I will call “institutional larceny phenomena,” changed all consumers’ attitudes about their credit reporting history. The multiple algorithm creators must account for explain and “include” these non-conforming societal distortion factors.
2. Massive Lender false reporting, miss-reporting and omitted reporting for borrower-loss-mitigation entries are not being accounted for and it is not just about the math anymore. The current math formula used is very bad.
Allow me to illustrate one example I have a friend who received a loan modification 2 years ago. She has made her modified payments perfectly on time via auto-draft from her bank account since then for 25 months. Those perfect payments are still not reporting on her credit report. Multiply this institutional larceny against consumers by 2 million people and it is reasonable to state that all credit bureau report-scoring models are now defunct and highly suspect.
3. We also may assume that the current credit scoring algorithms do not include the new buyers of Fannie Mae’s false short sale valuation of no-appraisal home path mortgages. A reasonable person with a high school education can conclude that these mortgages will soon be defaulting at an ALARMING HIGH RATE.
Their recent conclusions are “garbage-in garbage-out” analysis.
Very well stated.
I did forget to mention that the lending institutions seem to be including in teh stats the people that begin a recovery program and made all payments and then the recovery program was denied and SS forced upon them.
This is NOW a double failure statistically and many if not MOST of the people denied modifications had been paying on time to an agreed MOD program and the bank fraudulently changed the terms after it was begun. Thse people actualy could afford the home at the modified payments. Many have never had any other trouble with any other credit and pay all thier bills on time, including cards.
The real issue is that these people have a doulbe statistical hit, that was caused by fraudualent modification practices by a bank. They are included in the stats (double creit hit ,mod revoked and SS). They would probably have been better off with a BK (CH 13) and gotten on with life. Thier recover would be less than 4 years most likley. It will be 5-7 at least now.
Well written article, the interesting poiint to make is that the credit companies agree that future failure is LESS with a short sale. THere are only two points of a graph discussed, however, if one uses other points in the scoring system I am sure that there would be a significant deviation from one standard deviation in the model.
Statistically, while there is a credit score "hit" their own model shows that there is statistical significance. They credit companies did NOT give an "over time" recovery for these classes. I am sure that there is a difference in over time continued financial difficulty.
Notice that this graph is for RECENT activity. It does not include any information on long term (1 year plus etc.). The issue is at what time element does one have a better chance of good credit?
I say that the credit scorers are probably violating actuarial premise.
I would not be surprised if the rate of a second default is right on. A short sale allows a property owner an "escape" from their mortgage and usually at a loss to the lender. Though there is an impact to an individuals credit rating, it is not as hard as a full foreclosure. Given these "win-win" situations, I can see how a consumer could easily place themselves in that situation again thinking that they will simply take the same path out. It seems that the industry should step up and help consumers learn to gauge the pros and cons of buying property. Education would have gone a long way to preventing the real estate market collapse.
On the other hand, Simon, I think there is a large group of people who went through short sale who are not going to buy again for a while. I think the re-defaults could be multiple short sales, possibly.
That is true, there is generally a 2 year waiting period before a person who went through a short sale will be able to qualify for an additional mortgage. Even with the passage of time, a person's mentality and spending pattern are not likely to have changed which puts the borrower at a greater risk of foreclosure once again.
Great article and a good explanation of how behind the times FICO scores are. One of the main reasons my clients pursue a short sale is to KNOW the timeline. Here in CA., the foreclosure process dates are all over the map. At least I can keep them in tune with who's telling us what with their short sale!
The whole FICO system is a sham, with each rating agency using secret algorithms to determine scores. This is why you can have a wide swing in scores. The system needs to be standardize, and there should only be one rating.
this article is really hard to understand.
Toni - They are basically saying FICO treats short sale and foreclosure events similarly when credit scoring because the rate of subsequent default within two years is similar. The author disagrees with FICO reasoning, and I believe the author has some good points. FICO is basing its logic only on a couple of years of market/credit history with the short sellers.