In this article, we’ll help you understand what you can do to avoid foreclosure, how a foreclosure will affect your credit if this process is unavoidable, and how you can save your credit score from dipping lower than necessary. We’ll even give you some tips on how to fix your credit after foreclosure.
Going through a foreclosure is not only stressful, it will also negatively affect your credit. The good news is that you can repair your credit following a foreclosure. The negative effect of a foreclosure is temporary. In this article, we’ll help you understand what you can do to avoid foreclosure, how a foreclosure will affect your credit if this process is unavoidable, and how you can save your credit score from dipping lower than necessary. We’ll even give you some tips on how to fix your credit after foreclosure.
How Foreclosure Will Affect Your Credit
A foreclosure will decrease your credit score by as much as 100 points, add negative remarks to your credit report, and make it harder for you to get loans moving forward. A foreclosure will stay on your credit report for seven years from the date of your first missed or late mortgage payment.
Foreclosure proceedings only begin after you’ve had late or missed mortgage payments, which are reported to the major credit bureaus. Lenders consider your credit history and score when you apply for a mortgage and foreclosures and late payments have a negative impact on that credit history. It is important to maintain a positive credit score whenever possible, so that you can secure credit with favorable terms down the road.
If you dream of being a homeowner again, you’ll have to wait three to seven years before you can qualify for another mortgage after foreclosure. The exact timeframe will depend on the mortgage lender. If you’re applying for a mortgage loan from the Federal Housing Administration (FHA), you probably won’t qualify until three years after your foreclosure. If you qualify for a Veterans Affairs (VA) home loan, the wait may only be two years. But, if your foreclosed home was purchased using an FHA loan, you’ll have to wait three years to get a VA loan. If you’re applying for a conventional loan, you might have to wait seven years to qualify after foreclosure.
Ways To Avoid Foreclosure
You can generally avoid foreclosure by paying the amount you owe from missed payments, making arrangements with your lender, or modifying your current loan agreement. You may also qualify for special considerations due to the COVID-19 pandemic. If you have a HUD/FHA, USDA, or VA loan, you can request a forbearance up until September 30, 2021. If you’re unable to make payments because of the COVID-19 pandemic and you have a federally backed mortgage, the loan servicer must offer you options for deferment or reduced payment plans. You can also find local resources through the Federal Reserve by researching your region and your type of loan.
For many foreclosures, the following options are available:
1. Sell the house and call it even.
Selling the house and paying off your mortgage could put the foreclosure action to rest and allow you to get a fresh start. This is a good option if you can sell your house for the amount you owe.
You must sell the home before the foreclosure process is complete. Generally, a foreclosure can’t start until you’ve been delinquent for at least 120 days. Even after the process starts, you’ll have time to sell the house. The length of the foreclosure process will depend on your state laws. In West Virginia, it might take a couple of months. In Arizona, it could take years.
Some states require foreclosures to go through the courts in a proceeding called a judicial foreclosure. Other states don’t have that requirement. Foreclosures that don’t go through the courts are called nonjudicial foreclosures and the process is faster. Many mortgage contracts have a clause allowing for a nonjudicial foreclosure in states that permit these processes.
2. Complete a short sale.
If the house is worth less than you owe on your mortgage, your lender may agree to a short sale. This means that you’ll sell the house for less than it’s worth and pay the lender from the proceeds of the sale. In some cases, the lender will call it even and forgive the remaining amount. In other cases, you’ll still owe the remaining amount of debt that’s not covered by the sale. The remaining amount is called a deficiency balance.
Whether you’ll be held responsible for this balance will depend on your lender, your total debt, the value of the house, and state laws. A short sale will hurt your credit score, but you won’t have a foreclosure on your credit report for seven years, which is even worse. Sometimes when the remaining debt is forgiven, that amount is considered income by the IRS. In this case, there are tax consequences you’ll want to review first.
3. Ask for a deed in lieu of foreclosure.
A lender may offer you the option of a deed in lieu of foreclosure. With this option, you’ll sign the house’s deed over to the lender, and the lender will not pursue foreclosure. A foreclosure proceeding can be costly for lenders, so sometimes this option makes sense. An advantage of this option is that your credit score won’t suffer as much because your mortgage debt will be clear and won’t remain on your credit report.
4. Consider a loan modification.
Some lenders will permit borrowers to commit to a loan modification to avoid foreclosure. A loan modification increases the length of the loan and lowers your monthly payments. On the plus side, the monthly payments might be more affordable. On the negative side, you’ll be paying more in interest and more for your house over the life of the loan. Also, the bank can always begin the foreclosure process again if you can’t make the payments. If you pursue this option, make sure that you can reliably make the payments under the modified terms.
5. Request loss mitigation options.
If you’re interested in a short sale, loan modification, or deed in lieu of foreclosure, ask your lender about your loss mitigation options. Take a close look at your financial situation and the pros and cons of each option to decide what’s best for you.
What To Know About Credit Reports
Your credit report is the basis for your credit score. To determine your credit score, companies look at the information on your credit report and translate it into a mathematical formula that spouts out a final number. That number is your credit score.
Your credit report will contain the dates you asked for credit, the dates you opened and closed accounts, your credit limits and balances, and your payment history—including whether payments were made on time or late. Bankruptcies, foreclosures, and accounts in collection will also show up on your credit report. This history creates a picture for lenders and banks that want to know whether you’ll be able to successfully pay back loans that you apply for. They will look at your credit report and credit score before determining whether to extend you credit and whether the terms of any credit extended will be favorable.
What Is My Credit Score?
Credit scores demonstrate your creditworthiness and how risky it may be to lend to you. Lenders also use credit scores to decide what interest rate to charge you. If you have a lower score, you’ll likely be charged higher interest rates. Contrary to popular belief, borrowers don’t usually just have one credit score. A person could have many different credit scores.
If you apply for an auto loan, the lender may see a different credit score than a mortgage lender would when they run your credit report. That’s partly because each of the three major credit bureaus—Experian, TransUnion, and Equifax—produce different scores. And also because not all companies report to every credit bureau.
FICO scores are the most popular calculations used by mortgage lenders when they are determining a borrower’s creditworthiness. Vantage Score is another company used by some lenders and landlords. Credit score methods are models based on algorithms and mathematical formulas.
Credit scoring models and companies give different priorities or weight to the facts in your credit history. For instance, the FICO 8 doesn’t affect your credit score as negatively as other models do if you have only one late payment. The FICO 8 model is the most frequently used and combines information from Equifax, TransUnion, and Experian. By contrast, the FICO 5 model, which is often used for auto loans and mortgages, uses credit report information from Equifax only.
Credit score companies can change the formula and this can change your score.
The goal of a credit score model is to determine how risky it is for a lender to provide a loan to a certain borrower. The higher the borrower’s credit score, the better their credit, and the more willing a lender will be to lend them money. A higher credit score also often translates to lower interest rates, which saves those borrowers money in the long run. The Consumer Protection Bureau reports that most scores range from 350-850.
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Avoid Credit Repair Scams
Repairing your credit can be time-consuming, so you may be tempted to use a service to help. If so, be aware that scammers are out there. Unethical companies may use stolen Social Security numbers to target people in debt. Others may look at foreclosures, which are public records, to find potential victims.
Any company offering to wipe your credit report clean or requesting money upfront to fix your credit report is a scam. That’s because the Credit Repair Organizations Act prohibits companies from using false statements and from asking for payment in advance to do credit repair. There is also a law that requires credit bureaus to report accurate information. This is the Fair Credit Reporting Act (FCRA).
Though it may feel overwhelming, you can repair your credit yourself. Negative information on your report doesn’t last forever. Your current credit activity will push your credit history down. Meaning, that if you maintain healthy credit habits moving forward, your negative reporting will be pushed to the bottom of your credit report and your score will rise over time. Eventually, any negative reporting will disappear from your credit report.
Tips For Increasing Your Credit Score After Foreclosure
You can improve your credit score after foreclosure by taking the following action:
Monitor your credit reports and make sure everything is accurate. You can get one free credit report each year from each of the three major bureaus—Experian, Equifax, and TransUnion. You can also get a free report more frequently right now, due to opportunities inspired by the Covid-19 pandemic.
Dispute incorrect and inaccurate information to credit bureaus on their websites.
Confirm errors have been corrected.
Make timely payments.
Keep a close watch on your debt to credit ratio. Don’t use more than 30% of your available credit line whenever possible.
Build your credit with borrowing. A credit card is a good place to start. If you can’t get an unsecured credit card, start with a secured credit card, which allows you to pay money to a bank or credit card company to get a credit line in the amount you’ve paid. Your payments will be reported to credit bureaus and on-time payments will help build your credit. Eventually, you could qualify for an unsecured credit card.
Although foreclosure affects your credit, you’ll be able to fix your credit over time and weather the foreclosure storm until it passes. A foreclosure does not mean that you’ll never be able to have a good credit score again. If you take steps to repair your credit and build up your credit score, you could still qualify for a home loan, car loan, and credit cards. It will take time and persistence, but you can do it and move forward to create greater financial opportunities for yourself and your family.