FICO: Short-sale credit damage same as foreclosure

With short sales, homeowners work with a bank on a solution to get out of a house they may no longer be able to afford or have to sell urgently for some reason. That’s why some argue short sales shouldn’t damage a person’s credit score in the same way as foreclosures, which can be much more costly for banks.

So should the penalty for a foreclosure more severely damage a borrower’s credit score than a short sale? No, maintains a new FICO study.

FICO conducted a study to determine the credit risk associated with “mortgage stress events,” such as foreclosures and short sales, by analyzing data from October 2009 to October 2011.

“While it is true that short sales represent slightly better risk than foreclosures, they do not perform well enough to merit a more positive treatment in the FICO Score,” according to a recent blog post on the FICO website.

The blog post goes on to explain that one out of every two borrowers who undergo a short sale go on to default on another account within two years. Also, according to researchers, an overwhelming majority of borrowers who went through a short sale also had some other mortgage delinquency in their credit history.

“From a weighting perspective, all these mortgage events – short sale, foreclosure, deed in lieu – fall into the same heavyweight class, because they correlate with exceptional riskiness,” the FICO blog post notes. “They aren’t alone in that class either. Based on the data, consumers with short sales perform no better than consumers who have a severe delinquency (90-plus days past due), a collection, or a derogatory public record (e.g., bankruptcy, tax lien, etc.) on file.”