Purchasing a home is one of the most exciting events in life, a benchmark moment that often comes as the result of years of hard work and determination.
As you sign the closing papers on this momentous day, chances are you aren’t thinking about the possibility of giving up your home to foreclosure.
But if the unexpected happens and you find yourself struggling under the weight of financial hardship one day, you could be at risk of foreclosure and all the negative consequences that accompany it.
What Is Foreclosure and The Effects
Foreclosure takes place when a homeowner fails to maintain their set payments on the mortgage, violating the terms of the mortgage loan.
Foreclosure is embarrassing, stressful, and can have consequences on your personal credit, along with that of any co-signer on the mortgage.
In addition to affecting your current homeownership, foreclosure can be detrimental to your credit score.
While that may seem like a minor consequence compared to losing your home, your credit score has far-reaching effects on your financial future.
In fact, a low credit score can limit your ability to purchase another home or vehicle or access sources of credit in the future.
Before you dive into purchasing a home or making any financial decisions which could hinder you from faithfully making your mortgage payments, you should seriously consider the effects your choices could have on your credit.
In this guide, we’ll show you just how foreclosure impacts your credit score and share advice on rebuilding your score in the aftermath.
How Does Foreclosure Affect Your Credit?
Foreclosure has both long and short term effects on your credit.
According to a 2011 FICO study, foreclosure deals a heavy blow to your credit score. Just how much it impacts your score depends on a few factors.
To understand how foreclosure affects your credit, you need to know what goes into your credit score. The FICO score consists of five components:
- Credit Utilization
- Payment History
- Length of Credit History
- New Credit
- Credit Mix
Out of those five elements, your payment history weighs most significantly on your score, making up 35% of it.
Foreclosure comes after 3-6 months of missed mortgage payments, an ample amount of time to damage your payment history.
In addition to affecting your payment history, a mortgage is detrimental to your score because of the type of credit it is.
Each form of credit carries a certain amount of credit risk, the likelihood of loss a creditor takes on in granting a loan or line of credit to an individual.
In general, mortgages are considered to be a safe source of credit, because in order to obtain a conventional mortgage, you’ll need a good credit score.
To qualify for a mortgage with competitive rates, you’ll need an even stronger score, which demonstrates a history of responsible credit use.
Because a mortgage is a considerably safer form of credit, it carries a lot of weight with your credit score. As such, late or missed mortgage payments result in some of the most substantial drops in credit.
How Much Foreclosure Affects Your Credit
FICO’s report found that foreclosure can diminish a perfect FICO score to a poor one in a matter of months.
It also showed that individuals with higher credit scores are more significantly impacted than individuals with lower scores.
While higher credit score holders have more to lose following foreclosure, individuals with fair credit scores will see a major decrease in their score as well.
So how much does foreclosure actually impact your score?
FICO’s study looked at three credit profiles with standard credit use ranging from good to excellent.
Their findings showed that a consumer with an initial score of 780 could see a 90-110 point drop after a month of late mortgage payments.
After 60 days, that score could drop another 30 or more points.
By the point of foreclosure, someone with formerly excellent credit could face a drop of around 150 points.
Someone with an initial score of 680 might see their score drop an average of 85 to 105 points after foreclosure, putting them in the poor credit range as well.
In light of this information, you should carefully consider the consequences of foreclosure, not just on your homeowners status today, but on your finances in the years to come.
Even if your credit history and the rest of your credit utilization are on track, a foreclosure alone is enough to ruin your score and bar you from accessing funding for years to come, putting your future financial endeavors on hold.
How Long Does a Foreclosure Affect Your Credit?
In addition to exploring how much foreclosure affects one’s credit score, FICO’s report looked at how long foreclosure stays on a credit report.
On average, a foreclosure stays on your credit report for around seven years.
That means it would take seven years to completely recover from the damages done to your score by bankruptcy.
If you fall further than foreclosure and file for bankruptcy, your score could be affected for ten years.
Just as your initial score determines the severity of foreclosure’s impact on your credit score, it also influences how long foreclosure stays on your record.
For instance, it might only take someone with an initial score of 680 around 3 years to undo the damage of their foreclosure, whereas someone with an initial score of 780 would likely need 7 years to fully recover their credit.
While it may take the better part of a decade for your credit score to fully recuperate after being hit with a foreclosure, you can certainly see improvements before then.
Like any other credit factor, a foreclosure’s impact on your score lessens over time.
In under a year, you can see small improvements to your score. And after a year of responsible credit use, the impact of foreclosure significantly decreases.
How to Rebuild Your Credit After Foreclosure
With some careful credit utilization and strategic spending and borrowing, you can watch as, slowly but surely, your score climbs from poor to excellent
Use Credit Cards Wisely:
Credit cards can be your best friend or your worst enemy as you work to build and maintain good credit. Some creditors may close your account if they discover your foreclosure, but others won’t. If you have any credit cards already, keeping them open and making payments consistently will help to lengthen your credit history and improve your payment history and credit utilization.
Consider a Secured Card:
If you’ve dealt with a low score before, you know that getting approved for a credit card can be challenging. Enter secured cards, which are tailor-made to help individuals with low credit to boost their scores. Secured cards are simple – you make a deposit when you open the account. That deposit determines your credit limit, allowing you space to rebuild your credit at zero risk to the card issuer, a win-win for all involved if you make payments responsibly. Be sure to shop around before picking a card to ensure you get the lowest rates and reasonable terms.
Take Your Time:
Drastically improving your score won’t happen overnight. Waiting until you have a good score to apply for more credit improves your odds of approval. You should also consider how applying for new loans or lines of credit influences your score. New credit applications prompt a credit check, which can drop your score. Make sure you actually have a chance at meeting the qualifications before applying.
Work on Your Payment History:
Rather than jumping the gun and applying for every type of credit under the sun, make responsible payments on the sources of credit you have now and allow your score to improve based on those actions. Remember, payment history comprises 35% of your credit score. The better your payment history is, the higher your score will climb. Conversely, missing payments can be detrimental to an already hurting credit score.
Seek Professional Help:
Many rather look for help with repairing credit after such a hit on their score. This is certainly an option that can help you gain a better score and be in a better credit position in the future. We recommend Lexington Law as a top credit repair company in 2019.
No one wants to think about foreclosure, but millions of Americans find themselves faced with the difficult decision of giving up their homes in times of financial distress.
If you find yourself reeling in the wake of foreclosure, there is no need to give up hope.
A foreclosure can be a major setback to your personal finances, but the damages of foreclosure are not irreparable.
While it may take years to recover completely after foreclosure, you and your credit score can bounce back.