The Seven Deadly Credit Sins To Avoid at All Costs
- John Ulzheimer on 8/9/2010
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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?
Settlements
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.
Charge offs
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.
Voluntary Repossessions
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.
Involuntary Repossessions
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.
Foreclosure
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.
Short Sales
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.
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6 Comments so far
leave a commentWrong. Deadliest sin is using credit. There is no reason on the planet that you need credit.
Let your credit score drop to zero. If you don’t borrow money, you’re fine. You can even get a MORTGAGE without a credit score.
The credit score is just a carrot dangled in front of a consumer’s face to get them to worry and plan to borrow more money. It’s just a marketing ploy. It’s a gimmick.
Credit is the most marketed product in our country.
Because it makes people LOTS of money.
By costing those who borrow LOTS of money.
Wow. To each his own, I guess. Does your wife use credit?
Your theory may be true for the irresponsible borrowers who seem to get all the attention, but for those living within their means (believe it or not, there are millions of us…we’re the suckers paying for everything the other half consumes) credit has very little downside.
I use my credit card for almost everything. Literally, every purchase and every bill goes on it–my rent doesn’t, but when I move one of my priorities will be a place that lets me put my rent on my CC.
I have 1 credit card, a “student” Visa I got in high school with zero fees and a $500 limit. Once or twice a year I call them up and ask if I qualify to have my limit raised, and if they have any 12 month no interest (or whatever) deals going on.
I’m now a few years out of college, the limit on the card is about $16,000, but my balance seldom goes above a few hundred dollars. All those bills and daily purchases get paid off every couple weeks when I log in to my bank account.
By using it as a more flexible debit card, I pay nothing, have a large emergency borrowing reserve, get to pick when the transfers take place, and receive rewards for stuff I’d otherwise pay for in cash (hence wanting to put my rent on it). Oh, and though I’ve never financed a car or house, at 24 it’s helped me build my FICO score to 800.
As a debt free individual living well within my means, with a huge untapped credit reserve, I’d sure like to hear how this is a bad thing.
So in reading the deadly sins on FICO scores. What’s the best way or should I say the best/easier way to go if your deciding to throw in the towel. I’m disabled, husband getting laid off in construction job (in July his job canceled medical insurance-just like that, in 2 days – Now -you had ins. and then you don’t). Medical ins. is going to cost another 320. a month with a 7,500. out of pocket before they will even pay anything!! My credit cards have gone from 6.99% to 14.99%+ since last year, but the Federal Reserve is only charging banks 1/2%. No wonder why the economy is so messed up!!
So, Do you,
~debt consolidate?
~just be late on some of your bills here and there?
~file bankruptcy?
~or do you have a better idea to keep your score afloat?
~better yet, does it even matter anymore??
Sorry, for the bummer stuff – but it is what it is.
Have you considered that the sky-high interest rates and your likelihood of throwing in the towel (not to mention the lack of recourse when you do) just might be linked?
If you can’t see that your borrowing is expensive precisely because you are a high-risk borrower, you aren’t likely to ever repair your credit. At the end of the day, someone is letting you borrow with nothing backing it (no house to repo, etc), with nothing other than your word that you’ll repay.
If you’re in a group of people less likely to repay, they take more losses on you and thus charge you more for future borrowing. The only way to fix this is to borrow amounts you know you can repay, and demonstrate a steady habit of repaying.
No matter what any poverty-pimp politician tells you, you are not entitled to risk someone else’s money at arbitrarily low cost. The first step is to quit borrowing, and the second step is to consistently pay back what you borrow, forever.
It’s not bummer stuff….it’s life. Here are my thoughts but at the end of the day you have to be the one who decides.
1. Bankruptcy – Not the worst option but should be the last. Ch 7 gets you completely out of debt and gets creditors off your back. Downside, stays on your credit files for 10 years. And, monies you have saved would could be seized by your creditors.
2. Consolidate – do you mean consolidation loan? That’s taking on debt to pay off debt. Might make sense, might not. Run the numbers.
3. Settling – Not the worst idea but you will have to have 50-60% of what you owe in cash to make a legit settlement offer. If you choose this path then do it yourself, don’t hire a settlement company to do it for you.
The variable missing from your email…how much debt do you have? Any what kind of debt is it? Credit cards, mortgage, auto, other? That’s important.