Foreclosure is bad news for homeowners. It’s the legal process by which a lending organisation cancels the borrower’s right of redemption on the mortgaged property. Typically, a date is set by which the homeowner must pay off the entire sum owing to the lender, including the costs of the foreclosure proceedings. If the borrower fails to do this, the lending institution is free to force the sale of the property – generally by public auction – to recover the debt.
Foreclosure can be very traumatic for the homeowners. Aside from losing their home, and potentially still owing money to the lending institution if the house sale proceeds fail to cover the outstanding debt, there are significant credit consequences attached to foreclosure.
Reduced credit score
Foreclosure typically affects individual credit scores by around 250 points. Someone with a previous credit score of around 700 would drop to 450 or less after foreclosure.* The minimum FICO credit score, which is the first point of reference of lenders, landlords and employers, is 340, so a credit score of around 400 is at the low end of the scale.
This could seriously impact your efforts to rent a new home after foreclosure, as potential landlords will look at credit scores as part of the assessment of your suitability as a tenant. And if you’re also jobless, it may impact on your efforts to find employment.
Credit is denied
After foreclosure, you may not be able to get a new credit card or a personal loan to purchase a car. Even if you are granted credit, the interest rates will be considerably higher, as the lender has to offset the risk of default on the loan.
Credit reputation is lost
Foreclosure – like all adverse credit incidents – remains on your credit report for a minimum of seven years, so the credit consequences of foreclosure could be with you for years to come. However, if you can re-establish a good credit rating as soon as possible, you may find that it’s easier to get credit, and interest rates begin to fall again around two years after the foreclosure incident.
If foreclosure is the only negative event on your credit record, it will not have such serious consequences as would be the case if you also default on additional credit obligations.
Problems in obtaining a new mortgage
It’s unlikely that you will be able to get another mortgage for at least two years after foreclosure, and it could be considerably longer. Even if a lender is willing to make an advance, your interest rate will typically be three or four percentage points higher than prevailing mortgage rates. On the bonus side, many mortgage lenders are only interested in the previous three years of credit history, so as long as other credit obligations have been honoured, it may not be so difficult to obtain another mortgage as you may have thought.
In addition, if the foreclosure has reduced your credit score to less than 600, your lender may ask for a down payment of up to 20% of the property’s asking price before agreeing to a mortgage. If you can afford to save a significant deposit, this will demonstrate that you have learned from the foreclosure and are serious about owning your own home again.
In summary, although foreclosure can have severe credit consequences in the short term, it’s possible to counterbalance the effects of foreclosure by meeting other credit obligations on time. The further distant the foreclosure is, the less impact on your credit score, so use the initial two years following the foreclosure to take steps to re-establish your credit reputation.
Contrary to the advice of some so-called ‘experts,’ foreclosure does not mean you will never be able to get another mortgage or credit at a reasonable interest rate. It’s how you deal with the foreclosure that influences your chances of future credit, not the simple fact of foreclosure.