New Jersey bankruptcy Article

By JENNIFER SARANOW SCHULTZ
New York Times Article
January 5, 2010, 5:41 pm

Do borrowers taking part in the Obama administration’s mortgage modification program deserve a black mark on their credit records?

Lenders use special codes to let credit bureaus know what customers are borrowing and whether they’re paying on time. When the loan modification program, which lowers mortgage payments for homeowners who are behind in their payments or in danger of imminent default, was announced in February, lenders used an existing code, called AC, to signal that borrowers were participating in the program.

The problem for those borrowers, however, was the fact that the AC code signals that a consumer has made only a partial payment. That often had a significant impact on the scores of borrowers with good credit who had made all of their payments on time. A Treasury Department spokeswoman estimated that their scores could fall from 30 to 100 points, depending on other information in their credit file .

Why use an old code? The AC code was the closest fit, so the Consumer Data Industry Association recommended using it until it could develop a new one.

One Bank of America executive, for instance, confirmed in this recent New York Times article, that it reported borrowers who made timely payments before and after agreeing to loan modifications as making only partial payments. Presumably, the bank used the AC code, which damaged the credit of many borrowers.

But recognizing that participating in the modification program alone need not harm credit scores by default, the trade association, in cooperation with the Treasury Department, developed a new code, which took effect in November. “The administration felt that it was important to ensure that homeowners who faced foreclosure weren’t unfairly punished for seeking a loan modification,” said Meg Reilly, spokeswoman for the Treasury Department.

The new CN code signifies a loan modified under a federal government plan. It will have no impact on credit scores in the near future.

But will it ever? That depends on whether FICO, which creates the most popular credit score formulas for credit bureaus like Equifax, Experian and TransUnion, concludes that its appearance in a credit file is somehow predictive of late bill payments or other bad behavior. For what it’s worth, the old AC code is correlated with delinquencies and such.

“Our first opportunity to study the predictive value of the new CN special comment code will come later this year, after one of the national credit reporting agencies sends us a new sample of consumer credit reports for our use in redeveloping our scoring models used by that agency,” said Craig Watts, a FICO spokesman. As a result, the FICO scoring formula ignores the CN code in the near term.

Still, the new code is separate from current information about whether borrowers are delinquent on their payments or not. So borrowers with the CN code on their records that pay late will still see their credit scores fall.

In addition, the lenders themselves ultimately decide whether to use the new code. That said, industry best practice is to follow the guidelines, because it’s in all lenders’ best interests to have as much information as possible about potential borrowers, said Norm Magnuson, spokesman for the reporting trade association. For instance, a Bank of America spokesman said Monday that the bank is complying with the guidelines.

As a result, the exact impact of a loan modification on a credit score does depend on several factors as outlined here. (Check here for more details on how a person’s credit report information can influence the score and check here for other advice on improving a low credit score.)

As for those who are current on their payments and were in a trial mortgage modification before the new code was adopted in November (and thus got the “AC” black mark), Mr. Magnuson said the guidelines did not address such retroactive status. But Ms. Reilly, the Treasury Department spokeswoman, said the AC code would eventually be dropped for such people.

Ideally, banks themselves will replace the old code that damages credit scores with the new one that doesn’t (yet). If they don’t make the fix, borrowers should call and request it and file disputes with the credit bureaus asking for a correction of credit reports that have the old code.

But shouldn’t people with modified loans who never missed a payment not suffer a credit score decline under any circumstances? Industry experts believe that some mark is necessary. The reason: those getting the modifications in the first place probably pose more risk to future lenders, given that the mortgage modification program was devised to help people whose money problems make them vulnerable to foreclosure. “They are having financial difficulty, so there is some risk involved,” said Mr. Magnuson.

Do you think people getting loan modifications should escape a black mark? Why or why not?