photo: Reinante El Pintor de Fuego
When was the last time you applied for an auto loan, or a mortgage, or a personal loan? Do you remember signing paperwork or agreeing to certain terms online by clicking the infamous “click here if you agree” box?
Well, that piece of paper that you signed, and didn’t really read and probably don’t understand, is called a promissory note. It’s essentially your memorialized promise to pay someone else some sum of money under certain terms.
Those “certain terms” are not negotiable and they’re not suggestions. They are actual terms that lenders must demand be followed. Not following those terms is a huge problem for debtors (you) because they can lead to a default. And, of course, default isn’t exactly what you want showing up on your credit reports because they will stick around for a whopping seven years and can cause your scores to plummet.
Nobody has ever accused the world of consumer credit of being void of humor and the reporting of defaults is no exception.
They can be reported a variety of ways to your credit files, and each variation has a specific meaning. What is consistent is the fact that they’re all considered negative by FICO scoring and other credit scoring systems.
What Does a Default Look Like on a Credit Report?
You’ve defaulted on your promissory note and now the lender is willing to accept less than you owe them and consider the loan to be settled, but not paid in full. This is very common in the credit card industry, especially in the past few years.
A charge off is an accounting designation to identify debt that the lender has determined to be uncollectable. They’ve written off the debt and now want to realize the tax benefit of doing so.
This is when you decide to take your car back to the dealership or bank, hand in the keys and call it a day. Some people think this is a more eloquent way to be done with your auto loan or lease. It might seem that way but you’ve defaulted on your agreement to make payments. The only thing you’ve done is avoid the embarrassment (and cost) of having a visit from the repo man.
This is the exact same thing as a voluntary repo except you decided that you’d rather have the bank hire someone to come get it with the hopes that you’ll end up on Operation Repo.
This is a much more common occurrence in the past three years. This is the process whereby the mortgage lender takes physical possession of your home because it’s in default. There are a variety of ways to default on a mortgage loan but for the purposes of this article let’s just say the homeowner stopped making their payments. There are a lot of moving parts to a foreclosure and this certainly isn’t meant to cover them all but it can lead to an embarrassing visit from the local sheriff who knocks on your door at 8am and stands there while you empty your possessions on to the front lawn.
Forfeiture of Deed
As the rubber meets the road, this is the same as a foreclosure except you’ve chosen to leave rather than forced the lender to have you evicted. This is also called Forfeiture of deed in lieu of foreclosure, which is exactly how it would show up on your credit reports. Despite the fact that you cooperated and communicated with the mortgage lender, you’ve still defaulted on your loan obligations.
This one gets me worked up like you have no idea. A short sale is when the lender agrees to take less than you owe on the home and consider the loan to be paid. This is actually a very good way to dispose of a bad mortgage because the value of the home is generally higher than it would be if it was taken back and resold out of foreclosure. That’s also better for the local neighborhood because it takes a smaller bite out of the home values. The problem with short sales is that they’ve only just recently become a common option. And, as with anything new, there is immense confusion and flat out misrepresentation about the process and impact it will have on your credit. So, I won’t mince words: a short sale is just as bad for your credit as a foreclosure or any of the other aforementioned defaults. They are reported as either charge offs or settlements, both of which are accurate. There are small armies of real estate agents who are trying to drum up business by pretending short sales are actually better for your credit scores.
So there you have it, the seven deadly FICO sins. These all represent some form of default on a credit obligation. And while this is certainly not an exhaustive list of items that can damage your FICO scores, it’s a very good list to avoid.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and the author of the “credit history” definition on Wikipedia. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.