Foreclosed on? Just because you may have lost one home doesn’t mean you’ll never be able to buy another. But first, you need to engage in some credit score Rx.
“A foreclosure will cause a credit score to drop sharply, typically by 200 to 300 points,” says Andrew Housser, co-CEO of Bills.com, a free consumer portal of personal finance information. “That would drop a score of 700 – considered a ‘good’ score – to as low as 400 – considered pretty terrible.” The minimum FICO score is 340. This drop can affect your ability to not only purchase a home, but also to secure a car loan and even gain employment. “Lower credit scores can result in being denied credit, such as credit cards and car loans, and facing much higher rates for loans and even other items, such as insurance, that rely on credit scores,” notes Housser.
Don’t lose hope, though. While a foreclosure can remain on your credit report for seven years, it won’t ruin your credit score for life, adds Housser. “If you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years. The important thing to keep in mind is that a foreclosure is a single negative item. If you keep it isolated, it will be much less damaging to your FICO score than if you had a foreclosure in addition to defaulting on other credit obligations.”
In fact, The Federal Housing Administration will allow a new mortgage to be approved if a past foreclosure was more than five years old,” explains Alan M. White, assistant professor at Valparaiso University School of Law in Indiana. “The impact of foreclosure on your score diminishes over time, depending on whether you have other active, on-time accounts,” he explains.
Of course, it’s preferable to avoid foreclosure altogether. Here are some ways to accomplish that goal. (Keep in mind, however, that many of these options require you to resume normal mortgage payments at some point. If you can’t afford to resume payments, it may not be worth the effort required to stop or reverse the foreclosure process.)
• Lender negotiation: If there is a reasonable expectation that you will be able to resume making regular mortgage payments within a relatively short time frame, the lender may be willing to work with you to establish a payment plan to bring the loan current. “Especially in today’s market, this is a greater possibility,” says Housser. “Many individuals are having trouble due to an unexpected job loss, medical expenses, divorce or other personal trauma. If the situation has some resolution so that the regular payments may be able to be met again, it is worth it to call the lender.”
• Forbearance agreement: For a temporary hardship, the lender might grant you a forbearance agreement to lower – or eliminate – payments for a limited time.
• Loan modification: This entails a permanent change to the loan, such as lowering the payment and extending the loan’s term or incorporating any delinquencies into future payments. “Lenders are more willing to discuss this now than they were before,” adds Housser.
• Deed-in-lieu of foreclosure: In this case, the lender takes ownership of the home, but that will not eliminate the negative impact of a payment delinquency or foreclosure that has already begun. “Bankruptcy remains on a credit report for 10 years, but it can offer a way to become current in payments, which will improve the credit score,” White notes.
• Refinancing: It may be possible to refinance a mortgage for a lower interest rate and/or lower monthly payment. But if you have already had late payments on a mortgage, the interest rate offered may be too high to lower your monthly payment. Housser recommends using online rate comparison sites and calculators to determine the “real costs of refinancing.”
• Short sale: In a short sale, the lender accepts less than the mortgage debt when the property value has declined. “A short sale will prevent foreclosure,” says White. “However, if it takes place after foreclosure was initiated, the foreclosure and the related delinquency in payments will be reflected on the credit report.” The only way to protect the credit score fully is to maintain monthly payments until the house is sold.
• Chapter 13 bankruptcy: If the loan default is past the point of being resolved with the lender, you may file for chapter 13 bankruptcy protection. This protection requires you to resume making regular mortgage payments but allows the arrearage (being overdue in payment) to be repaid over the course of the chapter 13 plan.
All things considered, a foreclosure won’t ruin your credit rating forever. It will lower your credit score and remain on your credit report until you’re able to re-establish good credit — which takes time and careful planning. Consider your home purchase wisely.