Defaulting on a Mortgage: How it Affects Your Credit Score
Defaulting on a Mortgage: How it Affects Your Credit Score
Many consumers have taken a financial hit with the recent economic climate. As more people are defaulting on their home loans, it is interesting to see the impact on FICO scores.Â
What may be a surprise is how many wealthy people with good credit are going into foreclosure. A recent article by the Arizona Republic mentioned how affluent, savvy homeowners are choosing to default on their home loans based on weighing the pros and cons to such a decision. “Recent research suggests that affluent people tend to be the main strategic defaulters, and these individuals are also the ones who would sustain more serious credit-score damage. This chart shows the resulting credit scores for two hypothetical consumers – one with an average initial score of 680 on the FICO scale and another with a high initial score of 780.”
| Situation | Initial 680 Score | Initial 780 Score |
| Â | Â | Â |
| 30 days late on mortgage | 600-620 | 670-690 |
| 90 days late on mortgage | 600-620 | 650-670 |
| Short sale, no deficiency | 610-630 | 655-675 |
| Short sale with deficiency or foreclosure | 575-595 | 620-640 |
| Bankruptcy | 530-550 | 540-560 |
The savvy homeowner that sees their home investment as a money pit, may go ahead and buy what they perceive as a better home  purchase, perhaps a short sale, before they default on their original investment. In this way, they have good credit to purchase the new home before they take the hit to their credit score caused by the default of their original home purchase.
Improve Your Karma With Microlending
If you haven’t heard of microlending yet, you are not alone. Although it is primarily something that has been found in third world countries, the U.S. is also in the microlending market. What makes microlending unusual is that it can be done by just about anyone and the amounts that you lend can be quite small. Some of the proponents of microlending even suggest that these loans could help to end poverty.
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What Is It?
Microlending occurs when loans are made are small and/or are unconventionally secured, if at all. They are a means for people who could normally not receive credit to be able to obtain a loan. The idea is to spur entrepreneurship. Many people, often times women, in traditionally poor areas may come up with an idea for a business but may be unable to obtain financing. Originally starting in developing countries about 30 years ago, these loans were intended to build wealth and, with hope, end poverty. (Learn more about emerging markets in Evaluating Country Risk For International Investing.)There are two types of microlenders: For-profit and not-for-profit. eBay’s subsidiary, Microplace, is an example of a for-profit dealer. Those wanting to donate to an individual borrower can use their Paypal accounts to transfer money. Kiva, a well-known not-for-profit lending organization, doesn’t receive any interest on its loans, but the field partners through which loans are managed do charge borrowers interest. Kiva has some interesting statistics regarding its loans:
Total value of all loans made through Kiva: $105,084,510 Number of Kiva Lenders: 601,646 Number of countries represented by Kiva Lenders: 188 Number of entrepreneurs that have received a loan through Kiva: 261,312 Number of loans that have been funded through Kiva: 149,794 Percentage of Kiva loans which have been made to women entrepreneurs: 82.55% Number of Kiva Field Partners (microfinance institutions Kiva partners with): 106 Number of countries Kiva Field Partners are located in: 49 Current repayment rate (all partners): 98.04% Average loan size (This is the average amount loaned to an individual Kiva Entrepreneur. Some loans – group loans – are divided between a group of borrowers.): $402.88 Average total amount loaned per Kiva Lender (includes reloaned funds): $174.98 Average number of loans per Kiva Lender: 5.03 Data as of 11/27/2009 from Kiva.org Kiva and other organizations advertise the appeal of lending being a safe investment and a socially conscious thing to do. Developing countries have many people who are in great need of assistance, and the hope is that by donating to these people, the economies of their countries will benefit.
These loans are not only being made available overseas. U.S. entrepreneurs can also take advantage of this financing. In fact, small and private businesses make up more than 87% of all businesses in the United States – accounting for 900,000 newly-created jobs every year. And funding for these companies often comes from lending firms.
Criticism
It has been suggested that excessive interest rates have been charged in the microlending game. This is because there are no legal limits – and little government involvement – in this field.Researchers at MIT recently have worked on two papers that suggested microlending may not be as impactful as originally hoped. The research found that many microcredit clients actually use the monies they receive through lending on household items – debt, car payments and luxury items – rather than the businesses for which it was designated.
Becoming a Microlender
One of the first decisions you must make is whether to donate interest-free or not. In addition to lending through third party organizations, you can also become a lender on your own. If you do so, it is important to confirm that your client is reputable and has the intention of abiding by timelines, late payment policies and interest rates, as it relates to repayment of the loan.Conclusion
Microloans can become a valuable part of your charitable gift giving. Although these loans have no guarantee that they will be repaid – as is the case with any loan – you may be helping those in need as well as helping a depressed economy. Financial interest returns may be small or non-existent, but the money invested may be a charitable way to help out those in need.
For related reading, check out Microfinance Has Major Impact and Using Social Finance To Produce A Better World.by Diane Hamilton, Ph.D (Contact Author | Biography)
Diane Hamilton’s formal education includes a Bachelor of Science, a Master of Arts and a Doctorate degree in Business Management. She has an Arizona real estate license as well as certifications in the areas of medical representative, Myers-Briggs and emotional intelligence. With more than 25 years of business and management-related experience, her background includes working in many industries, including computers, software, pharmaceuticals, corporate training, mortgage/lending and real estate. She currently teaches business-related subjects for six online universities and is in the process of writing a book on personal finance for young adults. She can be reached through www.drdianehamilton.com.
Buzz up!
Need a Loan? Find Out What The Loan Officer is Thinking
It is awfully nice of lenders to be offering free loans. At least, that’s what it sounds like they’re doing. Think of all of the radio and television ads you have heard where the lender claims to be offering loans with no out-of-pocket costs. Have you ever wondered how they can do this? If they are not charging you, the money has to come from somewhere. It helps to clear things up when you understand how a loan officer makes their money.Â
Pay Now or Pay Later
Loan officers get paid in a way that they call “on the front” and/or “on the back.” If a loan officer makes money on the front, that means they are charging for things that you can see. This money is either out-of-pocket or is incorporated into the loan when you sign the papers. These are things like processing fees and other miscellaneous charges that are charged for processing your loan. If a loan officer makes money on the back, that means money is being received from the bank as a sort of commission for filing the loan. This is the money you do not see. (To learn more about loan expenses, read our related article How To Read Loan And Credit Card Agreements.)
When lenders claim to be giving you a “no out-of-pocket” or “no-fee” loan, they are still making money, but they are charging it on “the back.” Although the bank is paying the loan officer this money now, it is really coming from you the borrower in the form of a higher interest rate. Lenders that are not charging fees on the front can be charging a higher rate to make up for lost fees. In fact, the bank could be making a lot more money this way as they are getting a higher rate of interest for possibly 30 years or more. (Learn how interest rates affect change in the housing market, and how you can keep up, in How Will Your Mortgage Rate?)Comparing Loans
How do you compare loans to be sure which deal is the best for you? You need to understand something called the annual percentage rate (APR). When you apply for a loan, the loan officer must give you a good faith estimate. On that estimate, you can find the APR. The APR shows the entire cost of the loan to you on a yearly basis. It factors in what the fees cost as well as the interest rate. By comparing good faith estimates and their APRs, you can get a better idea of what they are charging you.
So is that loan really free? As they say, there is no such thing as a free lunch. You might not be paying money out-of-pocket right now, but either you pay now or your pay later. Many times it is a better deal to pay the fees now to get a lower rate instead of paying a higher rate over 30 years.
What the Loan Officer is Thinking
Remember, loan officers are sales people; they get paid by selling you something. In this case, they are selling you the loan. If they are telling you it is a good time to refinance, you need to figure out how much that loan is going to cost you. To do this, you must consider how many out-of-pocket fees you will be paying, if the loan interest rate is less and if you’ll be in the loan long enough to recoup these expenses. If you are getting a lower interest rate and not paying fees, it could be a better deal than what you have now. In that case, the no-fee loan could be a good idea. (Read The True Economics Of Refinancing A Mortgage to learn more about this concept.)
Be careful of the loan officer who wants to keep selling you adjustable rate mortgage (ARM) after ARM after ARM for the same property. ARMs are a good loan choice for certain people, especially those who know they won’t be in their home or loan for very long. If you are planning to stay in your home a long time, an ARM may not be a very good choice. Loan officers receive money for every loan they make. Therefore, it behooves them to make as many loans as possible. One way to do this is to get people into ARMs that need to be refinanced often. (To learn more about the dangers of adjustable rate mortgages, read This ARM Has Teeth.)
Broker or Bank?
Not everyone agrees on this. Having worked for both, I can tell you that there are good and bad brokers, and bankers. The advantage of using a broker is that they can shop around at the different banks for the lowest rates. The advantage of using a bank directly is that they don’t have to pay the broker. If the broker can find a lower rate, charge the broker fee, and still offer the lowest total rate, then that may be your best choice. You will have to do your homework and compare good faith estimates to be sure. Remember, the loan officer decides how much money they want to make to some extent; they may have some negotiating room. Don’t always expect that brokers are giving you the best rate that they can. They may not be telling you the lowest rate they can offer because by offering the rate they quoted, they may be getting more commission on the back. (Read Score A Cheap Mortgage to learn more about getting the best rate.)
Do Your Homework
Though many loans given by loan officers/banks during the subprime meltdown of 2007/08 ended in foreclosure, you don’t need to be that concerned, not if you do your homework. One of the biggest problems came with letting the lending requirements get too lax. Banks were granting loans to people that they used to deny. Something called the stated loan became more common. People were able to “state” how much money they made instead of having to prove it. Many people stated more than they actually made. Also, underwriters were under pressure to approve loans that may not have made sense because they were in competition with other banks that were approving these loans. Remember, it is all sales in the end.
Conclusion
How do you protect yourself? Do your homework. Shop around. Do not accept the first good faith estimate. Get several estimates. Compare the APR on each one. Go to both brokers and bankers to see what they offer. Be wary of the loan officer that doesn’t ask you how long you will be living in your home. If they don’t ask you questions, they don’t know which loan fits you the best. If you are planning to only be in your home a short time, you might consider an ARM. If you are going to be there for a long time, consider a 30-year loan. Even better, if the day comes and you can afford it, pay extra each month on your 30-year loan and pay it off in 15 years!
by Diane Hamilton, Ph.D