Foreclosures and your credit score

16692099_MIf you’re experiencing financial difficulty, you might be unable to make monthly mortgage payments. While putting food on the table and catering for your family might your top priority, the lender’s primary concern is minimizing losses. And as a result, you could find yourself in danger of foreclosure.

A foreclosure is a bitter experience – not only do you lose your home, but it also leaves a negative impact on your credit score that will considerably limit your ability to qualify for new loans or mortgages for several years down the line.

What is Foreclosure?

A foreclosure occurs when a mortgage lender takes possession of a borrower’s property after the borrower fails to keep up with their loan payment. The lender is legally entitled to seize and sell the property to recoup as much as possible from the loan.

The Foreclosure Process

The variables affecting the foreclosure process vary from state to state. But in general, the process begins if you’re three to six months behind your mortgage payment. Other factors like failure to pay property tax or keep up with house maintenance can also trigger the foreclosure process.

To initiate the pre-foreclosure process, the lender sends a Notice of Default, at least, three months after being behind in monthly payments. Thereafter, the homeowner has a grace period of three to four months to work out a viable solution with the lender to avoid foreclosure. If no agreement is reached after the grace period, the lender may publish a notice of sale, at least, 21 days before the foreclosure auction sale date. If no solution is worked out, the lender can sell the home at an auction to the highest bidder.

There are three types of foreclosure:

  • A judicial foreclosure
  • A power of sale foreclosure
  • A strict foreclosure

However, they all involve the eventual sale of the home, with some minor subtleties in their process.

Avoiding Foreclosure

Lenders and government agencies have several other programs that can help homeowners who want to avoid foreclosure. Some include special forbearance, loan repayment plans, refinancing options, and loan modification programs

A special forbearance temporarily suspends the monthly mortgage payments to allow the homeowner to pay up past-due amounts.

In repayment plans, the past-due amount is added to the current loan balance with the understanding that the lender will gradually pay them all.

Refinancing enables you to secure new loans with better terms.

Loan modification enables you to renegotiate the terms of your mortgage to make payments more affordable.

You should consider these options if you still have a steady income to make payments but you’re facing temporary financial hardship. On the other hand, if there’s no feasible way to make mortgage payments, a foreclosure might be inevitable.

How Would a Foreclosure Affect Your Credit Score?

A foreclosure will have a devastating impact on your credit scores, second only to the effects of declaring bankruptcy.

First, a foreclosure entry will appear on your credit report within one or two months after the initiation of the foreclosure proceedings. Sadly, the entry will remain in your credit for the next seven years, starting from the date you first missed the payment that instigated the foreclosure.

How Low Will Your Credit Score Drop?

The number of points you’ll lose as a result of foreclosure depends on several factors. However, the most important factor is your credit score before the foreclosure.

Contrary to what you might assume, the higher your prior credit score, the steeper the fall after a foreclosure. As an example, if your score is just under 800, you might lose between 145 and 170 points. Alternatively, if your credit score sits at 675, you will lose anywhere from 90 to 110 points.

By the way, even before a foreclosure appears on your credit report, your credit score might have taken a significant dip due to a series of missed payments. If you’re missing payments in other debts as well, then you should expect an even bigger blow to your credit score. At the end of the day, it’s not uncommon for a person to lose a total of about 250 points.

Negative Effects of a Foreclosure

Since a foreclosure lowers your credit score and stays in your report for seven years, it can have a series of devastating impacts.

Difficult In Securing New Loans

Every lender sets its lending criteria, but it’s safe to say that foreclosure is considered a derogatory event by all lenders. When lenders see a person with foreclosure, all they see is a person who is likely to default on their payments. Many lenders would not even consider an applicant with a foreclosure. Some may be forgiving if the foreclosure happened a long time ago.

Even if you’re able to secure a new loan, the cost of borrowing will be significantly higher because you’ll be considered ‘high risk’. Research suggests that borrowers with credit scores below 500 pay 2% higher in interest rate compared to those with scores above 660.

Employment Restrictions

Some employers – especially in the financial sector or government space – use your credit score to determine if you’re a reliable candidate. A bad credit score can prevent you from securing employment from such organizations.

Recovering From a Foreclosure

Although a foreclosure will stay in your credit report for a long time, the road towards recovery should start immediately. Change your spending habits and live within your means so that you can start paying your bills on time. If possible, try your best to pay off balances rather than just paying them down as it will have a stronger positive impact. Ensure that you keep your credit low and minimize your credit card spending. Also, ensure you monitor your credit report so that you can resolve any discrepancy, should it arise.

Transitioning will be rough and challenging but if you develop positive credit habits, your credit score will improve. Need help? We’re here for you. Contact us today!

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