Life After Foreclosure: Rebuilding Your Credit and Getting Back on Track

Losing a home to foreclosure can be a traumatic experience. Even in the best case, it’s a major hassle that seriously hurts your finances. After going through a foreclosure, it might be difficult to imagine having a normal life. But there’s hope. There are many ways to rebuild your credit that will make it possible for you to be a homeowner again. But before we explain what these options are, let’s begin by discussing what a foreclosure is and what it does to your credit history.

What Is Foreclosure? 

If you default on a mortgage loan, your lender can repossess your home and sell it through foreclosure. The lender then applies the proceeds from the foreclosure sale to your unpaid mortgage balance. This process is legal because mortgages are secured loans, with your home acting as collateral. It’s difficult to explain the exact foreclosure process because every state has its own foreclosure laws. For example, in some states, only judicial foreclosures are allowed, which means they have to go through the courts. In other states, lenders can pursue judicial and nonjudicial foreclosures, which don’t have to go through the court.

What does it mean to default on your mortgage?

As if that’s not complicated enough, the foreclosure process will also be governed by the mortgage and promissory note. These documents outline what constitutes a mortgage default. Most foreclosures result from the borrower defaulting on a mortgage loan. This occurs when the borrower fails to make their monthly mortgage payments, which can happen for many reasons, including:

• Loss of a job

• A major medical emergency or severe illness

• Death of a spouse

• Divorce

• National disaster

• Other unmanageable debt payments, such as credit card bills

• Rising interest rates that increase the monthly payments of an adjustable-rate mortgage

But even in situations where the borrower can continue making their mortgage payments, a foreclosure can still occur if:

• The mortgage is underwater. This occurs when the home has negative equity, which means it’s worth less than what you owe on the mortgage. This makes selling the property or refinancing the mortgage difficult. This leaves you with few options. You can continue making payments or walk away from the mortgage.

• You violate a term from the mortgage contract, such as not properly insuring the property. Lenders require homes to be properly insured because if the property gets damaged, it can reduce the property’s value. This could result in the property not having enough value to fully secure the loan.

Most borrowers who are facing foreclosure will have two major concerns. The first is finding a new home. The second is how much the foreclosure will hurt their credit score.

How a Foreclosure Affects Your Credit 

When it comes to foreclosures and credit, the question isn’t whether a foreclosure will harm your credit — it’s how much of a negative impact it will have. Foreclosures show up on your credit report for seven years. And while it’s on your credit report, it’ll lower your credit score. How much it lowers your score will vary. It depends what your credit score was before the foreclosure and how much other debt you have. 

Keep in mind that much of the damage to your credit score will occur when you miss your first few mortgage payments and before foreclosure proceedings have begun. This is because your payment history (including missed payments) makes up a major component of your credit score. These three to four missed payments can cause your credit score to drop 100 or more points. Then once the foreclosure appears in your credit history, you can expect a further drop in your credit score.

Other Consequences To Consider

Because of the damage it does to your credit, foreclosure can mean more than just losing your home. It could make it more difficult for you to find a job or place to live since some employers and landlords review your credit history before hiring you or agreeing to let you rent property from them. 

Foreclosure can also negatively impact your tax bill. If your home is sold at a foreclosure auction for less than what you owe on your mortgage, you’ll have a deficiency balance. Your lender may try to get a deficiency judgment to collect this deficiency or they may choose to forgive the debt. If they forgive or cancel the debt, you could owe taxes on it. And if your home sells for a profit at a foreclosure sale, this profit may also come with income tax liability.

Getting New Credit in the Future

Then there’s the difficulty in obtaining new credit. Prospective lenders will see that you couldn’t repay your mortgage loan, so they may be wary of lending you money. If they do approve you for a loan, the terms will likely be more expensive. You may have to make a larger down payment, have access to a lower credit limit, and be subject to a higher interest rate. 

This can make it impossible or expensive to make large purchases. For example, if you need a new car, you might have to settle for buying a used one with cash instead of getting a new car with a car loan. Or if you’re moving into a new apartment, your security deposit could be two months’ rent instead of just one month’s rent.

All of this sounds bad, but there’s good news, too! The negative effects of foreclosure don’t last forever. If you improve your finances, you can also improve your credit score. After a few years, it may be possible to get another mortgage or another type of loan with credit terms that are comparable to what you could have gotten before the foreclosure.

Rebuilding Your Financial Foundation After Foreclosure 

You can rebuild your credit after foreclosure. Many people are or have been in your shoes. According to the FDIC, one in every 200 American homeowners will be foreclosed on. In 2010, one of every 45 housing units in the U.S. was foreclosed. The foreclosure rate has since dropped, but in 2019 about one out of every 280 homes was being foreclosed. All of this is to show that foreclosure happens to a lot of people. If foreclosure permanently destroyed your credit, the U.S. economy wouldn’t exist as we know it!

If you’ve recently gone through a foreclosure, there’s a way to get your financial life back. If you aren’t sure how to proceed, don’t hesitate to ask for professional advice. It’s normal to feel overwhelmed by credit scores, finances, and budgeting! A good place to start is with an accredited, nonprofit credit counseling agency. You’ll have the chance to get a free credit evaluation and talk to a credit counselor. During this discussion, you’ll get a better grasp of your credit situation and what your best options are for improving your credit history.

Getting Another Mortgage After Foreclosure

If you lost your home because of foreclosure, you can still get another mortgage to buy a home. But it’ll take time to get to that point. There are several reasons for this. 

First, there’s typically a waiting period before a lender will approve a mortgage for someone who has a foreclosure on their credit report. For instance, if you want to apply for a Federal Housing Administration (FHA) loan, you’ll have to wait up to three years after your foreclosure before you’ll be eligible. Other mortgage lenders may have a longer or shorter waiting period. You can reduce the waiting period for an FHA loan, but you’ll have to show that the reason for the foreclosure was out of your control, like a job loss or medical bills.

If the waiting period has passed, you’ll still need to show that you’re unlikely to default again if you want to get approved for another mortgage. This means proving that whatever caused your foreclosure is no longer present or is unlikely to happen again. In practice, this means having a good credit score. A general rule of thumb is to have a credit score above 620 before you can reasonably expect to get approved for another mortgage.

Assuming that you qualify for another mortgage, you’ll probably need to have saved up enough to make a large down payment. This could easily be 25% or more of the home’s value. Depending on the value of the home you want, this may be impossible. It will also help to have extra cash available to handle larger monthly mortgage payments. As a condition of loan approval, some lenders may ask that you agree to pay a higher interest rate than you would if you didn’t have a foreclosure in your credit history.

Improving Your Credit After a Foreclosure

When it comes to getting life back to normal after a foreclosure, there’s only so much you can control. One of the biggest things you can control is your credit score. Getting your credit score back up not only makes it easier to get approved for another loan (like a new mortgage), but once you get approved, a higher score will make the loan more affordable through a lower interest rate.

So, what can you do to raise your credit score after a foreclosure? This question is best answered by addressing what goes into a credit score. A FICO score (one of the most common types of credit scores) is calculated by looking at the following five factors:

1. Payment history

2. Amount of debt

3. Length of credit history

4. The existence of any new credit accounts

5. The types of credit 

As mentioned earlier, your payment history is the most important component and makes up 35% of your FICO credit score. This means that one of the best ways to boost your credit score is to pay your bills and other credit payments on time. You should do everything in your power to avoid late payments. The longer you can keep this up, the more your credit score will rise. 

The second most important component of a FICO credit score is the amount of debt you currently have. This makes up 30% of your credit score. Future lenders will look at how much of your available credit you’re actively using. This is your credit utilization rate. Most lenders prefer to see applicants with a credit utilization rate of below 30%. So, if you want to increase your credit score quickly, work as hard as you can to carry the smallest balances possible on your credit accounts. Ideally, you want to have no balances carrying over from month to month. In other words, pay off your credit cards in full each month.

Other strategies for raising your credit score

In addition to the above tips, you can also raise your score by:

• Avoiding opening new lines of credit. New credit accounts result in hard credit inquiries. These will temporarily reduce your credit score. Sometimes opening a new credit account or having a hard inquiry is inevitable. But if you don’t have to get a new credit card, it’s best to not apply for it.

• Practicing good money habits. Examine what caused your foreclosure and do what you can to avoid those circumstances. This might mean creating a budget, having a larger rainy day fund, or cutting down on your living expenses.

• Monitoring your credit history. You can do this by getting a free copy of your credit report from one or all of the three major credit bureaus (Experian, Equifax, and TransUnion) once per year. If there are any mistakes or inaccuracies, it’s a lot easier to fix them if you notice them quickly. You can also make sure no one else has stolen your identity to open a credit account under your name.

Let's Summarize... 

Going through a foreclosure is difficult. And once it’s over, there’s the challenge of dealing with the aftermath of bad credit, which can create significant challenges. You might have trouble getting approved for a mortgage, getting offered a new job, or getting approved for an apartment lease. 

But the good news is that you can improve your credit score and reduce the negative effects of the foreclosure on your credit history. You can do this by reducing the amount of credit you’re using and paying your bills on time. And even though a foreclosure will remain on your credit report for seven years, its negative effect will diminish over time. After a few years of good financial habits, you should qualify for most loans, including another home loan.