Should FICO scores ignore recent foreclosures?

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The unprecedented wave of foreclosures is certainly weakening the social stigma that comes with giving up a home, and Todd J. Zywicki, a professor of law at George Mason University says that it may also result in a dulling of the impact foreclosure has on credit scores.

''It just seems obvious that a foreclosure in 2008 or 2009 doesn't have as much information value as a foreclosure five years ago,'' he says. ''To the extent that foreclosure doesn't predict future behavior as much as it did in the past, you'd expect that the FICO algorithm would change to adjust for that.''

While providing FICO score relief to victims of foreclosure has a certain intuitive appeal to it, it actually might be a terrible idea. First, it would make FICO scores even more useless than they already are. Second, it would eliminate the one remaining reason that people have not to give up homes they're underwater on.

One of the primary motives behind all the housing stimulus programs has been to reduce the amount of inventory on the market in distressed areas. If you give people on more reason to give up their homes, the hardest-hit markets could be even more flooded than ever. About 52% of Nevada mortgages are underwater, followed by 32% in Arizona and 30% in Florida and California, according to First American CoreLogic.

Without the FICO score deterrent, 52% of Nevada home owners with mortgages would have every reason to abandon their homes. That would spell disaster for that housing market.

A better solution is for the FICO score's treatment of foreclosures to remain unchanged -- or present two numbers, one that reflects the foreclosure and one that doesn't. Then leave it to the lender to decide how much he cares about the foreclosure.
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