Credit Consequences of Foreclosure

For people who have watched their house price plummet, and their mortgage plunge deep underwater, a foreclosure may not just seem like an economic necessity but even a relief. In many places it is possible to walk away from a mortgage and preserve most other areas of one’s finances. However, there are very serious credit consequences of a foreclosure on a mortgage.

– About Credit Scores –

A credit report is an important set of financial information stored about them by each of the major credit reporting agencies (Equifax, Transunion, and Experian). It contains information about all loans and other forms of credit extended to a person, such as credit cards, lines of credit, car loans, and, of course, home mortgages. A payment more than 30 days late is listed as a minor problem; more than 60 days late, a more serious problem, and so on. Loan defaults, mortgage foreclosures, and bankruptcies are also listed.

This information is important because when a person applies for a new loan or mortgage, the bank orders their credit file and uses it to produce a “credit score,” a rating that indicates how well they’ve handled credit in the past and, on that basis, whether they seem likely to be a good or bad risk for the bank in the future. On the standard scoring system, known as FICO, people above 700 have good credit and people below 600 have quite poor credit. A lower credit rating means you are more likely to be given a higher interest rate, or simply refused entirely the next time you approach a bank for a mortgage or another type of loan.

– How Foreclosures Affect Credit –

Foreclosures can have extremely serious consequences for credit ratings. Under the FICO system, a person with a decent rating may see a drop of 150-300 points, bringing them down into high-risk territory. There are several ways this hit takes place.

First, foreclosures are usually followed by numerous late payments piling up, followed by bills that go completely unpaid, until the bank is finally convinced that no payments will be made. These payment problems go on a person’s credit report, too – and late payments result in a penalty, with or without an eventual foreclosure.

Second, the foreclosure itself goes on the report because it is a form of default, much the same as if you failed to make your car loan payments until the dealership repossessed the vehicle. (Of course, losing a home is far more stressful and traumatic than losing a car.) Options to escape foreclosure, like a short sale, can salvage a person’s finances to some extent, but still have a serious impact on their credit score.

Finally, if the foreclosure is only part of a person’s financial problems, and they also have to file for bankruptcy, then the bankruptcy itself also is registered on the credit score and has the most serious penalty of all.

Once a credit score is seriously lowered, it becomes more difficult even to get easy, “cheap” credit, like credit cards. People with low credit are often given higher interest rates, or simply refused a loan altogether on the grounds that they are poor risks. Fortunately, bad information is eventually removed from a credit information file. In most cases, lenders are aware that people can “turn over a new leaf,” as it were, and pay most attention to problems within the past two years. However, depending on your state, a foreclosure will remain on your credit file for 7-10 years before the law requires that it be removed.