How do foreclosures and bankruptcies affect credit scores?
FICO (the credit scoring company) sends out a e-newsletter with interesting information. The latest one included a question about the impact foreclosure has on credit scores. If you are a foreclosure investor, you should understand this. Here’s the question and answer as published by myFICO.
Dear myFICO,
It's inevitable that I will have to let the bank foreclose on my home. I just can't afford the monthly payments and I can't refinance because my home is worth significantly less now than when I bought it. Will this foreclosure ruin my FICO score forever? Are there alternatives to foreclosure that will save my credit? Is declaring bankruptcy better for my score?
Aaron
Tampa Bay, Florida
Dear Aaron,
I'm very sorry to hear about your predicament. Over the last few years we've received a lot of questions about foreclosures and their effect on your FICO® score. The Mortgage Bankers Association recently estimated that 1 out of every 200 homes in the US will be foreclosed upon - so there are many homeowners dealing with this difficult situation. I'll address each of your questions, but limit my responses to our area of expertise: FICO scores. However, you should consider doing additional research to understand all of your options prior to making decisions regarding your home.
Before addressing your specific questions, let me ask you this: did you contact your lender? If you anticipate mortgage trouble, we always recommend reaching out to your lender. Your lender may be willing to work with you to find a solution that would keep you in your home.
How will your FICO score consider a foreclosure?
There's no denying that foreclosures are considered a very negative event by your FICO score. With that said, it's a common misconception that a foreclosure will make it impossible to rebuild your credit. In fact, if you keep all of your other credit obligations in good standing, there's a good chance that your FICO score could begin to rebound in just 2 years. Try to pay your auto loans, credit cards and any other credit obligations on time to limit the effect of this foreclosure.
Are other options better for my credit standing?
Recently, several alternatives to foreclosure have become popular - some of these include "short sales" and "deeds-in-lieu of foreclosure". These may be viable options for you, and you should definitely do research to determine if these options make sense for your situation. However, as far as your FICO score in concerned, there is no difference between foreclosures and short sales or deeds-in-lieu of foreclosures. Each of these actions is considered an account that was "not paid as agreed", and will have the same impact to your FICO score.
What about bankruptcy?
While both foreclosures and bankruptcies are considered very negative items by your FICO score, a foreclosure can be isolated to a single account (your mortgage account). Often, bankruptcies involve multiple accounts that are "not paid as agreed", so bankruptcies have the opportunity to be further reaching than foreclosures. However, if you're unable to pay other credit obligations in addition to your mortgage, you may need to consider bankruptcy.
While the reality of losing your home to foreclosure is difficult, there is a real possibility that you can rebuild your credit in a relatively short amount of time. Keep in mind that a foreclosure is just one negative item on your credit file and as time passes, its impact on your FICO score will lessen. From the entire myFICO team, we hope this information has been helpful and that you find your financial footing again soon.
Learn more at www.myfico.com.
Comments
I am very confused!
Aren't we told over and over how much Foreclosure is worse than bankruptcy?
Here it says that Short Sales are about the same on your credit score as foreclosure.
I don't get it!!!
Posted by: orit baklasko | May 24, 2008 09:32 PM
I hope we can clear up your confusion.
First, foreclosure is not worse than bankruptcy as far as the impact on your credit rating goes. Both are negative, but a foreclosure covers one account you couldn't pay, and a bankruptcy typically covers multiple accounts. Also, bankruptcies can be reported in your credit file for up to ten years, while foreclosures are typically removed after seven years.
Second, in the case of a short sale, the reality is that the borrower has not paid as promised, and the lender can report that to the credit bureau. How much it will affect an individual's credit score depends on the total picture, including the status of the individual's payment history with other creditors.
Keep in mind this article is discussing how FICO scores are calculated. There are other credit scoring systems that may view short sales differently. You can also try to negotiate what is reported to the credit bureau as part of the short sale agreement.
Keep in mind that many lenders look at credit scores as only part of the overall picture when considering a borrower's creditworthiness. It's possible that a lender would look far more favorably on a borrower with a short sale rather than a foreclosure on his record, because the short sale shows that the borrower took the initiative to try to make the best of a bad situation rather than simply giving up.
Posted by: Jackie | May 27, 2008 08:04 AM