How Foreclosure Affects Credit Score

The impact of a foreclosure on your credit score can be devastating--and long-lasting. Les Christie of CNN Money reports that FICO estimates that losing a house through foreclosure--or similar scenarios such as a short sale or a deed-in-lieu--can cause a credit score drop of 85 to 160 points.

Types

While foreclosure is often seen as an inevitability for those who cannot pay their mortgage, homeowners and lenders alike have begun to employ other ways of discharging the debt--ways that are just as harmful to your credit score.

The short sale, a popular option in recessions fueled by decreased home values, allows the seller and/or lender to sell the home for less than the mortgage, with the lender forgiving the difference.

In a deed-in-lieu transaction, often employed by owners who are not upside down in their mortgage, but no longer wish to pay the mortgage or who have had no buyers, the owner turns the home over to the lender in exchange for a discharge of the debt.

Significance

Maxine Sweet of Experian, one of the nation's three major credit reporting bureaus, reports that the damage a foreclosure does to borrowers' credit scores is not related to the foreclosure so much as the fact that you paid less than what was owed--a semantic difference.

In essence, the foreclosure, short sale or deed-in-lieu is seen as debt that was settled for less than what was owed.

History

Even borrowers with great credit histories will find their credit scores affected by foreclosure. Those who choose to leave the home before foreclosure or short sale proceedings have begun, either through a deed-in-lieu agreement or simply by walking away from the mortgage, will fare no better.

"Some borrowers may think that because they never missed a payment, they can 'walk away' from their homes with relatively little impact on scores," says FICO's Daniel Watts. "When a deed-in-lieu or short sale is reported as a partial payment, it's treated as a serious delinquency just like a foreclosure."

Potential

The impact of a foreclosure or other mortgage discharge will be drastic.

"The point loss also depends on the borrower's starting point," says Christie of CNN Money. "People with very high credit scores have more to lose than low-score borrowers; the impact of a single blemish on an 800 score is more than on a 500."

Expect a credit score drop of "about 85 points for the 680 score borrower to as much as 160 for the 780 score [borrower]," Christie warns.

Prevention

MSN Money's Liz Pulliam Weston recommends avoiding foreclosure if at all possible by consulting a legitimate consumer credit counseling agency, attempting to refinance or attempting loan modification.

"It's far better to sell a home while you still have equity and some semblance of a credit score than to have it taken away in foreclosure," says Pulliam Weston.