How will a foreclosure affect my credit?

Foreclosures occur when a property owner is unable to make his or her mortgage payments and the banking institution that holds the loan takes ownership of the property in question. Apart from declaring bankruptcy, defaulting on mortgage payments is likely the most detrimental hit someone can experience to their credit score.

This is important because credit scores are likely the single largest determinant of whether an applicant will succeed in obtaining the loan they require to purchase the home they want. Credit scores are generally provided by FICO, and they fluctuate depending on payment and credit history.

How does a foreclosure work?

A foreclosure can cause a credit score to drop by up to 300 points since it’s likely the largest debt someone will ever incur. The size of the drop depends on the borrower’s previous payment history. Since credit scores only range from 300 to 850, such a drop would diminish even a perfect score to an unfavorable level, forcing the borrower to opt for an extremely expensive subprime mortgage or FHA loan. There are a few important things to know when undergoing a foreclosure:

  • This event will not only affect an applicant’s ability to obtain a new mortgage—should they choose to do so in the near future—but can also deny them credit card opportunities, car loans, and even disqualify them for basic insurance discounts.
  • There are alternatives to foreclosure under the “Home Affordable Foreclosure Alternatives” (HAFA) program, such as short sales or deeds in lieu of foreclosure. However, many credit score providers—including FICO—do not rate these alternatives any better than a foreclosure when determining credit scores.
  • Foreclosures cannot be removed from a credit report for at least seven years. Nevertheless, their impact can begin to be reversed in as little as two years.
  • There is also a difference depending on the reason for your foreclosure. If the reason was beyond your control, such as illness or divorce, you may wait less time than those who simply walked away from a mortgage or underestimated their adjustable-rate mortgage payments.
  • A foreclosure mandates a minimum waiting period before obtaining a new mortgage. A prime—or conventional—mortgage requires seven clean years, while the FHA requires only one.
  • If the borrower makes the decision to purchase another home with a partner in the future, the foreclosure will still affect the ability of both loan signatories to obtain the mortgage in question. While the negative impact of the foreclosure does not transfer directly to the other signatory’s credit score, it will likely increase the qualifying interest rate offered to the applicants.

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It’s important to remember that a foreclosure does not last forever. Credit scores can be rebuilt by paying off credit card balances every month and taking out minimal loans. Your score will be re-established much quicker if the foreclosure is the only negative incident on the report. This means that, despite being foreclosed-on, the borrower should make sure to pay all other bills on time. Once they can prove to the bank that their finances are stable and that they can faithfully make all payments, the bank will begin to extend credit to the borrower again