Credit Consequences of Foreclosure

Losing a home through foreclosure is a bitter experience which will have a significant negative impact on ones credit reports and score. A foreclosure is considered second only to a bankruptcy and it will remain on credit reports for a minimum of seven years as a matter of public record. However there are many variables which influence how much impact a foreclosure will have. It is possible for credit scores to recover within two years depending on how other credit obligations are dealt with following a foreclosure.

Impact of foreclosures on credit scores.

Most usually a foreclosure occurs when the homeowner cannot meet their mortgage payments and other obligations. Missed payments prior to a foreclosure will cause credit scores to fall between 40-110 points. A recorded default is considered a serious delinquency resulting in a further fall of between 70-135 points. Thus the average point loss associated with a foreclosure is around 110-250 points.

A foreclosure will cause credit scores to fall more if the score was high prior to default, whilst it will fall less if the credit score was average. If the credit score was already low prior to a foreclosure the less it will fall. If the foreclosure is an isolated incident and all other credit obligations are current, it will have less overall impact than if other bills are already recorded as late.

Strategic defaults and credit consequences.

Strategic defaults are becoming more common as homeowners choose to walk away from underwater mortgages. As this tactic is used deliberately to avoid making future payments on a home with negative equity, it is often practiced by those who otherwise have good credit and are able to maintain their other credit obligations.

Whilst a strategic default may have a lesser impact on credit than foreclosures which are forced, the long term impact could be worse. If state law allows it, lenders are more likely to pursue strategic defaulters with deficiency judgments than borrowers who lost their homes due to debt.

Deficiency judgments require borrowers pay the outstanding amount of the mortgage balance after foreclosure, plus the associated costs of the foreclosure including legal fees, with interest. The most likely scenario is that the strategic defaulter will need to declare bankruptcy or pay the amount due under the deficiency judgment. If bankruptcy is opted for as a method of avoiding the payment, this will then be recorded on the credit reports for ten years and have a more severe impact than the original foreclosure.

Credit recovery after foreclosure.

It is possible for credit to recover within two years of a foreclosure. Craig Watts, speaking on behalf of Fico, advises that those who pay all their bills on time, keep credit card balances low and only take on new credit when necessary, should expect to see a recovery within two years. The foreclosure can be removed from credit reports after seven years by sending a written request to the three main credit bureaus.

Providing that good credit is re-established after a foreclosure, it is possible for new mortgages to be issued within 2-4 years depending on the policy of the lender. Lenders are expected to tighten their criteria against those who engaged in strategic defaults as they are deemed very high risk, and in general strategic defaults will probably result in mortgage costs being higher in the future.