Effect of Foreclosure on a Credit Rating

Credit ratings are a popular topic lately. The housing crisis forced many people to make extreme decisions that effected credit reports. Salvaging credit scores is important to many homeowners. Unfortunately one of the most negative impacts to a credit rating is foreclosure. Determining the impact of a foreclosure is not an exact science, however, it is possible to estimate the percentage decrease of a foreclosure.

Foreclosures

Foreclosures occur when homeowners can no longer keep up with the payments

Late payments, missed payments and defaults lead to a foreclosure. Banks try hard to avoid foreclosures and often work with homeowners to find other solutions. Foreclosures mean that a bank will have to take possession of a home and sell it, usually for below market price. In the event that the bank sells the home for less, they may attach a judgment to the homeowner for the shortfall. Foreclosures remain on a credit report for seven years. A foreclosure on a credit report is considered very negative and effects the chances of opening new credit accounts and obtaining better interest rates. Lenders will not finance another mortgage for at least two years or more after a foreclosure.

Credit Scores

Credit scores determine a consumer's potential risk

Credit scores determine everything from utility deposits to interest rates on car purchases. Scores from three national agencies (Equifax, TransUnion and Experian) make up the FICO score. These scores range from 300 to 850. Scores lower than 600 can mean higher interest rates or rejected credit applications. A foreclosure can cause a score to drop from 115 to 140 points. Bankruptcies cause the score to drop by up to 365 points. Late payments contribute to payment history, which makes up to 32 percent of a FICO score, so on-time payments are crucial to rebuilding credit.

Improving Credit Scores

A foreclosure on a credit report reflects less negatively than a bankruptcy, but it is still damaging. After a foreclosure, rebuilding credit becomes the main priority. Paying bills on time is the key to creating a healthy credit profile. Checking the credit report is important for the homeowner after a foreclosure. Review the report carefully and report errors immediately. Paying rent and credit accounts on time will build a solid credit history. The impact of the foreclosure will start to diminish over time. Having sound credit after the foreclosure shows creditors and lenders that the foreclosure was a onetime event.

Find Help

Be careful of credit-rebuilding scams that require upfront payment. Legitimate debt counselors exist, but you have to do the research. Never pay money to anyone who promises a quick credit fix. There are no quick fixes. Only a history of on-time credit payments will overcome a negative credit history. Debt consolidation is an available option for some. but a careful review of accounts needs to happen first. Contact account holders directly to negotiate lower interest rates and payment terms. Creditors are willing to work with account holders who put forth a good-faith effort.

Other Options

Before considering foreclosure, homeowners should exhaust all other measures. The Economic Stimulus Program offers many options to homeowners, such as short sales, refinancing and loan modification. Homeowners must reach out to lenders, before falling into foreclosure trouble, for loan modifications to improve the chance of rebuilding credit. If selecting a short sale instead of a foreclosure, the impact to credit will still be substantial but sometimes not as much as a foreclosure. In some cases, the drop is up to 130 points, but previous payment history plays a large role.