Guest Author: Jeff Davis, General Counsel for RE/MAX equity group
During this recession, many homeowners are being forced to make difficult decisions when they come to realize that they can no longer afford their homes. They know they are going to have to make major changes, such as moving out and dealing with their creditors. What they may not know is how these decisions are going to affect their ability to get back on their feet. When the recession ends and we all get our financial houses in order, what will be the quickest way to get back into an actual house?
Obviously there are many things to think about, and financial and legal advisors should be consulted for help. But an accountant or lawyer may not know all the details of how these decisions will help or hinder a buyer in their next home purchase. This information is critical to those who want to deal with these difficult choices in the smartest possible way.
Creditors immediately report bad news – late payments, bankruptcies, foreclosures, etc. – to the national credit bureaus (TransUnion, Equifax & Experian). That information affects our credit scores for months, or even years. Just how long, and to what extent, is primarily determined by two companies and one federal law:
- The Fair Isaac Corporation (named after its two founders) analyzes our credit information to produce FICO scores. The range of scores, along with the percentage of people who have those scores, is 300-499 (2%), 500-549 (5%), 550-599 (8%), 600-649 (12%), 650-699 (15%), 700-749 (18%), 750-799 (27%), and 800-850 (13%), so the average score is about 700. Scores are based on (in declining order of importance) our payment history, credit capacity utilization, length of credit history, types of credit used and history of recent credit applications. The number of points deducted from a credit score for a derogatory event is calculated using secret, complex algorithms that take into account hundreds of factors. So these point deductions are not published, and the numbers in the table below are based on examples appearing at www.myfico.com.
- The Federal National Mortgage Association (“Fannie Mae”) regularly publishes its “Selling Guide: Fannie Mae Single Family.” Fannie Mae isn’t quite the government; it is a government-sponsored enterprise, but it might as well be the government because it has the gold, and therefore it makes the rules! Here’s why: Fannie Mae and its (her?) cousin, Freddie Mac, own or guarantee more than half of the mortgage loans issued in the United States. Loans that conform to the rules set by Fannie and Freddie are called “conforming loans.” Because Fannie Mae controls so much of the residential mortgage market, the law of supply and demand dictates that conforming loans are easier to obtain and bear interest at lower rates than nonconforming loans. So when Fannie Mae sets rules, they affect every potential buyer. The rules we are concerned with here state how much time a potential buyer must wait after a negative credit event before applying for a conforming loan.
- The Fair Credit Reporting Act (15 U.S.C. §1681 et seq.) sets limits on how long credit reporting agencies may report negative information. There is no law requiring negative information to appear on a credit report for a certain period of time. So if a person is able to successfully negotiate the way a creditor reports a negative event before it is reported, the credit reporting agencies will report it that way.
Here is how derogatory events affect buyers and their credit scores:
|Derogatory Event||Points Lost a||Reporting Limit||Waiting Period Requirements||Waiting Period with Extenuating Circumstancesb|
Chapter 7 or 11
|130-240||10 years||4 years||2 years|
|130-240||7 years||• 2 years from discharge date
• 4 years from dismissal date
|• 2 years from discharge date
• 2 years from dismissal date
|Multiple Bank-ruptcy Filings||130-240 ea||7 to 10 years||5 years if more than one filing within the past 7 years||3 years from the most recent discharge or dismissal date|
|7 years||7 years||3 years|
|Additional eligibility requirements after 3 years up to 7 years:
• 90% maximum LTV d
• The purchase of second homes or investment properties and cash-out refinances (any occupancy type) are not eligible
|Deed-in-Lieu of Foreclosure and Short Sale||85-
160 c, e
|7 years||• 2 years — 80% max LTV d
• 4 years — 90% max LTV d
• 7 years — other LTV d
|2 years — 90% max LTV d|
|Miscellaneous f||25-150||7 years||No waiting period – impact is on credit score and report only.|
|a Ranges are shown because the point loss depends on how many points someone has to lose in the payment history factor of his or her score. A person with a high score loses more points than a person who already has a low score.
b Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations. Examples include divorce, high medical expenses, or losing a job. Extenuating circumstances must be relevant and documented.
c If a deficiency judgment or tax lien is filed in connection with a foreclosure, credit scores can drop an additional 100 points. And payments received late or not at all will have already impacted the credit score.
d Lower maximum LTV ratios are sometimes applicable, depending on the transaction type (principal residence or investment), number of units, the financing type (purchase or cash-out refinance), and credit score. Required credit scores range from 620 for a single-unit-home with an LTV below 75%, up to 680-700 for multiple unit properties, high LTV loans, some second homes/investment properties, or where cash is being taken out in a refinancing.
e These alternatives to foreclosure are all “not paid as agreed” accounts, and are therefore considered the same as foreclosure by FICO scores. Their advantage is in the shorter wait required to apply for a conforming loan.
f Miscellaneous events are civil suits, civil judgments, records of arrest, paid tax liens, accounts placed for collection and other adverse items of information. But there is no limit on reporting periods for reports used in connection with (i) a credit transaction involving $150,000 or more, (ii) life insurance with a face amount of $150,000 or more, or (iii) employment at an annual salary of $75,000 or more.
FICO scoring, federal law and Fannie Mae’s rules can be changed at any time, so all of this is, of course, subject to change.