Loan modifications lower FICO scores

For many years, a borrower’s mortgage application and purchase plans in the housing market hinged on receiving a satisfactory (or better) FICO score. This number stemmed from Fair Isaac’s rating operation and is currently used by all three major credit bureaus: Experian, TransUnion and Equifax. Recently, FICO revealed how various activities will likely affect borrower’s scores; this information was traditionally kept hidden away as part of the statistical mystique of the mortgage finance system.

Recently, a Real Estate Today article was referenced by realestateconnections.tv/blog (and this same table has also been reported elsewhere) showing the following sample results:

For Borrowers with a sub-prime 680 score

(and an eight-year credit history with two delinquencies)

• Maxing out a credit card: reduces FICO by 10-30 points
• Produces a one-month delinquent payment: reduces FICO by 60-80 points
• Settles a credit card balance without full payment: reduces FICO by 45-65 points
• Agrees to a short sale: reduces FICO by 55-75 points
• Accepts a foreclosure: reduces FICO by 85-105 points
• Declares bankruptcy: reduces FICO by 130-150 points

Consider the impacts on a less risky borrower:

For Borrowers with an excellent 780 score

(or one who has not missed a payment in 15 years)

• Maxing out a credit card: reduces FICO by 25-45 points
• Produces a one-month delinquent payment: reduces FICO by 90-110 points
• Settles a credit card balance without full payment: reduces FICO by 105-125 points
• Agrees to a short sale: reduces FICO by 115-135 points
• Accepts a foreclosure: reduces FICO by 140-160 points
• Declares bankruptcy: reduces FICO by 220-240 points

Clearly, it is difficult to get a good FICO score and over time, to keep it. As many in the industry have noted, taking care of your credit record is quite important and as the evidence above shows, your record is sensitive to any lapses or mistakes.

The US Treasury Department announced the Home Affordable Modification Plan on March 4 and it was widely heralded to rescue as many as seven to nine million troubled homeowners with a $75 billion budget. The program consisted of two parts: Home Affordable Refinance (intended for four to five million households) and Home Affordable Modification (for three to four million additional borrowers). Almost everyone acknowledges that it has not worked: to date, only about 160,000 loans have been modified.

Newly announced government plans call for reductions in mortgage balances. Many of us have argued that unless old debts are written off and borrowers come out from being “underwater,” households will not treat their homes well. The new thinking is to write down the old mortgage balances, although there are many who think this is rewarding bad behavior.

Here’s the rub: whether providing cheap refinancing options, attractive terms via loan modifications or reducing existing outstanding loan balances, there is a problem. It comes as a surprise that borrowers’ FICO scores have been significantly reduced by any of these actions. Even though borrowers are trying to work with lenders and the government programs, one of the unintended consequences of these actions is to penalize borrowers with considerably lower FICO scores. Further, this impact will last up to seven years. One recommendation warns “if you want to maintain a good FICO score avoid opting for loan modification.” (Source: mortgagecases.com)

What a system!  Even if one works to modify an old loan in order to avoid default and foreclosure, one’s credit score takes a significant hit. It’s a tough world out there.

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Tags: fico, jaffe, loan

This entry was posted on Thursday, April 15th, 2010 at 6:00 am and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed.