The system used by the American credit reporting industry to report the history of consumer payments to creditors to the national credit repositories has a serious flaw, according to some members of the mortgage industry. This flaw is the lack of a specific code for short sale mortgage transactions. With the current mortgage climate of millions of short sale consumers needing properly documented accounts of their previous mortgage problem so they can re-enter the housing market, this problem is reaching epidemic proportions in some of the hardest hit regions of the country. There is speculation that this flaw could be holding back the recovery of the housing market, as many short sellers are prohibited from re-entering the housing market for a longer period of time than required by lenders.
Metro2 is the coding format used by the national credit repositories and the creditors to set the operating procedures for the data in the credit reporting system. It was created by the Consumer Data Industry Association (CDIA), a trade association dominated by the three credit repositories: TransUnion, Experian and Equifax. Anyone working with credit reports much will quickly identify most of the Metro2 codes. In looking at a tradeline for a consumers payment history shown as an “R-1” for example; the “R” stands for Revolving Accounts like credit cards, “I” for Installment, etc., and the number portion representing the last payment status. As in the “R-1” example, the “1” represents the account being paid as agreed, a “2” represents paid 30 days late and higher numbers steadily indicate later payments on up to the dreaded “9” rating, which indicates the account is in collection. While this is just a portion of the many codes in the system designed to handle all of the various scenarios possible in every aspect of lending covered by the American credit reporting system, as of today there is no specific code for a mortgage transaction via short sale.
Short sales are difficult to deal with due to the complexity of the transaction, and are reported with a foreclosure status. Historically this worked, as a short sale transaction was traditionally in conjunction with foreclosure activities. In today’s mortgage marketplace, especially in light of the Federal Housing Finance Agency’s (FHFA—the government agency regulating Fannie Mae and Freddie Mac) short sale policy statement of Nov. 1, 2012, that allows homeowners to short sale without ever being late on their mortgage, the old system of reporting short sales needs updating.
Some in the industry believe this is a problem and are working on it; others seem to believe that the status quo is the best route and reporting short sales with a tie to a foreclosure is accurate. Considering the mortgage crisis we are struggling to overcome, and the numbers of consumers who were put into extraordinary circumstances, I believe that the system needs to be carefully reviewed and altered as many consumers who short sell today are much better credit risks that the pre housing crisis foreclosure consumers. It seems that others in the industry have similar beliefs.
In a May 2011 report by Steven Chaouki, a group vice president at TransUnion, titled “Life After Foreclosure and Hidden Opportunities,” he presents a hypothesis that would indicate:
1. Defaulting on a mortgage causes temporary excess liquidity. This excess liquidity masks the true risk of the consumer as he goes through the foreclosure process, and
2. Certain consumers who defaulted on a mortgage in the recent recession only did so because of the recession—they are otherwise good credit risks.
Another person who is very critical of the current system is Pam Marron of Bankers Mortgage who has spent the past 24 years originating mortgages in the Tampa, Fla. market. This is one of the regions devastated by the housing crisis and she sees this issue as “one of the greatest problems facing the housing market in its struggle to rebound.” In working with Tampa area homeowners who have been plagued with this reporting problem over the past couple years she has documented two major problems for homeowners:
1. With no short sale specific code the reporting of a foreclosure status results in a denial of a mortgage in both Fannie Mae and Freddie Mac automated underwriting systems. This stalls past short sellers from re-entering the housing market, even after the required timeframes for reentry after the short sale have passed.
2. Many lenders are still telling underwater homeowners that they must be delinquent on the mortgage to get short sale approval, contrary to the new FHFA short sale policy. This enables the continuation of the current system of reporting short sales as a foreclosure.
Since over the past couple years Pam has had to deal with more short sales in the Tampa market than mortgage originators in most other parts of the country, she has identified two solutions to the problem. One a quick term band aide type approach to help consumers right now, then the long term fix that may require government assistance to ultimately provide the correction needed on a systemwide basis.
The quick fix is to get the short sale lender to provide a letter at closing to the underwater homeowner that simply states “this mortgage closed as a short sale, not as a foreclosure. Any credit markings reflective of a foreclosure should be deleted.” This letter can be used by the mortgage credit reporting agency to correct the repository data to more accurately reflect the short sale status.
The long term fix, and the one that brings much greater challenges, is the creation of a specific short sale code added the Metro2 system so that this manual step is no longer needed. This would allow the lenders to properly track the short sellers in the automated underwriting systems. It would also set up the proper tracking to determine if the short sellers created from the housing crisis are a different credit risk than traditional foreclosures so that this category of transactions can be properly evaluated for their true credit risks. That will require system changes, analysis and those take time when talking about systems as large as those that operate the United States credit reporting industry.
One closing thought that has been provided by many mortgage originators recently on how to help the mortgage market improve, for lenders that do not follow the FHFA Short Sale policy effective Nov. 1, 2012 be held accountable for their disregard of the policy. They report to many consumers still being told that they must be delinquent on their loan to short sale. With the CFPB and Congress looking at the credit reporting industry and the mortgage market closely, it’s possible that the forces to create these changes are in place and help may soon be on the way for the estimated 16 million still underwater American homeowners.
Terry W. Clemans is executive director of the National Consumer Reporting Association (NCRA). He may be reached at (630) 539-1525 or e-mail [email protected]