How Does a Short Sale Impact Credit Scores Versus a Foreclosure?

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Although short sales are often chosen as a better alternative to foreclosure, the possibility of jeopardizing the seller’s FICO score is a real possibility. There is the mindset that a short sale demonstrates that a homeowner is willing to work with the lender and should be commended rather than punished. It is also argued that short sales are not as costly for the bank as a foreclosure and the penalty to one’s credit score should also reflect that. Yet another stance is that the current mortgage crisis was unprecedented, and those caught up in it should not be so severely punished.

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To take a look at these arguments, the Fair Isaac Corporation, now officially FICO, conducted a study examining recent instances of “mortgage stress events”. The period between October 2009 and October 2011 was analyzed. FICO’s findings verify what many have suspected. That is, “short sales and other events of recent mortgage distress continue to represent a high degree of risk.” The analysts at FICO also confirm that the current risks linked to short sales match the findings of earlier studies, which indicated that they are better risks than foreclosures.

However, they do not do well enough to warrant a higher FICO score. In the study of borrowers who experienced a short sale, one out of every two went on to default on another account within two years. That is considered high risk, especially when the majority of those turning to short sales had further issues of delinquent mortgages.

In FICO’s view, short sales, foreclosures, and the situation of a deed in lieu are all red flags for exceptional risk.

Foreclosure and Short Sale Inventory Report

Foreclosures are continuing to hit the open market as a back log of distressed homes, otherwise known as shadow inventory, are being released. For the past two years, this shadow inventory has been building, as the robo-signing fiasco caused a market slow-down. Now, as foreclosed properties are being released to the open market, some metros are seeing a dramatic increase in foreclosures. Nationally, however, the foreclosure inventory has actually decreased since a year ago.

According to a recent report by real estate research firm, CoreLogic, approximately 1.4 million homes, or 3.4% of all homes with a mortgage, were in the national foreclosure inventory compared to 1.5 million, or 3.5% a year earlier.

Experts say that while this appears to be good news, it could simply be the quiet before the storm. It is estimated that the current back log of shadow foreclosure inventory represents only about 39% of the 3.6 million foreclosures completed across the country since the start of the financial crisis in 2006.

Here’s a look at the states with the highest foreclosure inventory:

Florida (12.0%)
New Jersey (6.7%
Illinois (5.3%
New York (5.0%)

The five states with the highest number of completed foreclosures for the 12 months ending in April 2012 also accounted for 48.8% of all completed foreclosures nationally:

California (142,000)
Florida (92,000)
Michigan (60,000)
Texas (58,000)
Georgia (57,000)

As for short sales, homes that are being sold in order to avoid foreclosure, certain markets are seeing big jumps in inventory. Las Vegas, Nevada is seeing its short sale inventory begin to eclipse foreclosures while in southern California, short sales account for more than 50% of all MLS inventory.

Real estate gurus tell us to expect more foreclosures and short sales in the near future, as these discounted and distressed properties continue to hit the market. While we may not be out of the woods yet, there is a silver lining. The influx of discounted property and historically low interest rates could offer a well-priced opportunity for first time buyers. And with the government’s Home Affordable Refinance Program, many homeowners with Fannie Mae or Freddie Mac-owned mortgages can avoid foreclosure by refinancing at today’s low rates.

Steph Meyer is a contributor to the ForTheBestRate.com Blog and keeps us up to date on interesting happenings within the world of home financing and real estate. She’s got a quick wit and keen eye on making smart financial decisions. My Google Profile+

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